The basic idea behind modern option pricing theory is that it may be possible to duplicate the payoff of an option using a self-fianncing and dynamic replicating portfolio strategy, investing only in the underlying asset and cash. However, we must always keep in mind that the modern theory has some important limitations. First, while replication may be successful before trading costs, net of trading costs it may fail. Of course, in practice this is a relative matter.
Replication is never exact.
Some underlying assets like real estate may be so illiquid or indivisible as to prohibit replication entirely. In other cases, other derivatives such as futures, which can be presumed to track the underlying asset price closely, can be used as substitutes for the underlying asset to reduce substantially the impact of trading costs. Most pension plans are prohibited from borrowing on net or from short selling . Such investors are clearly not in a position to replicate certain types of option positions, such as uncovered calls or puts. However, almost all investors can buy underlying assets and lend, so covered calls and protective puts are feasible payoff targets.