Research On The Risk - Benefit Of Option - Based Supply Chain Contract

Option contracts can reduce the risk of retailers resulting from the demand uncertainty.Generally, a put option can be purchased to reduce the losses due to the lower market demand and a call option can be purchased to reduce the losses of caused by high market demand. In this paper we consider a single-period contract model in supply chain where an option be put in to establish supply chain contract model based on options.The pricing mechanisms of the option is acceptable to both sides, and the retailer not only chooses the order quantity but also determines the strike price and the strike quantity of the option. As the buyers of the option, the retailer pays the option writer an amount which equals a risk premium plus the expected option payoff, and receive the compensation from the option write according to the option contract. Mainly considering both the benefits and risks of the retailer and using the mean-variance method, we show the efficient frontier of the retailer come and discuss their decisions.We find that an unilateral option in traditional supply chain contracts can make the retailer purchasing products more flexible and having less risks, but at the same time it will reduces the expected profit of the retailer. To improve and enhance the unilateral option, we bring a bidirectional option into the contract which also have the same situation that will reduces the expected profit of the retailer. Through analysis on the retailer’s efficient frontier, we can also find that purchasing a bidirectional option may not be better than an unilateral option or not purchasing a option in supply contracts. All kind of these contracts mentioned have the chance to be the best one for the retailer. Retailers need to consider both the benefits and risks, optimize the business decisions, and choose the best contract based on the actual and specific situation, rather than blindly believe that the the option contract is the best.