01 Jan 2001, Energy Risk glossary , Energy Risk
Also known as portfolio insurance, this is a technique for replicating an option payout by buying or selling the underlying or futures contracts in proportion to movements in the theoretical option’s delta. Essentially, it is delta hedging with nothing to hedge. Those trying to replicate a long option position lay themselves open to increases in market volatility, but benefit if volatility declines. Synthetic replication is generally used if implied volatility of options is thought to be too high.