What is replicating strategy?
This is a way for traders to find the value of an asset by replicating its cash flows or price movement using other assets whose values they already know.
Where have you heard of replicating strategy?
They’re mainly used to hedge the risk exposure that comes from writing options. The strategy can shift a portfolio’s exposure between a riskless and a risky asset, or between two or more risky assets, to produce the same payoff.
What you need to know about replicating strategy.
It’s known as a dynamic trading strategy and usually involves exchange traded assets with the same net profit. So for example, if a trader wants to price or model an asset, they would use this strategy to replicate its price movement in terms of other assets whose values they already know. For example, they could replicate the cash flows of an inverse floating rate bond with spread by using a combination of floating rate bonds, coupon bonds and zero-coupon bonds.
Find out more about replicating strategy.
To learn more about this type of strategy, check out our guide to replicating portfolio.