Bidirectional Option Contracts Research Articles

Multi-Level Supply Chain Emergency Reverse Based on Bidirectional Option Contract

Multi-Level Supply Chain Emergency Reverse Based on Bidirectional Option Contract

Call option contract in a supply chain with random yield and random demand using downconversion approach

PurposeThis study aims to examine the value of the call option contract in hedging the risks in the supply chain. The decentralized supply chain without call option contract is first studied as the criterion model for evaluations. This paper addresses several questions: What will be the optimal manufacturer’s production quantity, retailer’s ordering and pricing policies in the presence of random demand and random yield by applying the downconversion approach? How will the call option contract influence the optimal decisions for the members of the supply chain? Can the risk from randomness be divided among the members in the supply chain through the call option contract?Design/methodology/approachThis paper considers a two-level decentralized supply chain under random yield and random demand in which the manufacturer takes advantage of the downconversion approach with two scenarios, with and without option contract. To the best of the authors’ knowledge, no article or study uses the downconversion approach in a supply chain regarding random yield and random demand. Furthermore, the paper considers pricing with option contract in the supply chain, which makes this article stands out significantly from other articles in the literature.FindingsThis study shows that the downconversion approach would reduce the risk caused by the random yield, which appears to be the appropriate method for the environmental goal of the supply chains. Moreover, adopting a call option contract can increase flexibility and mitigate risks, resulting in more expected members’ profits.Research limitations/implicationsTo simplify the model, the authors assume one manufacturer and one retailer, so extending the model to consider multiple retailers instead of one retailer and inventory sharing between them would be interesting. Considering the option and exercise prices as decision variables would be important future research topics. Put option and bidirectional option contracts could be investigated in the future. Another extension is modeling asymmetry of information in supply chain.Originality/valueThis paper provides managerial insights on dealing with both demand and yield risks in a manufacturer–retailer supply chain. The manufacturer has a random yield production and produces two types of vertical products: low-end and high-end. To reduce waste caused by the random yield, the manufacturer uses a downconversion approach in which low-end products are made by converting the defective high-end products. The manufacturer purchased a shortage of high-end products from the secondary market (i.e. emergency sourcing). High-end products are sold through the retailer, and low-end products are sold directly by the manufacturer. The customer demand for high-end products in the end market is random and depends on the selling price, and the customer demand for the low-end products in the secondary market is independent and random. The retailer contracts the manufacturer with the call option to obtain high-end products to meet a random demand; in fact, by using the call option contract, the authors try to balance the risks between two members. Two scenarios of with and without call option contract are proposed. After the high-end product demand is observed, the retailer would exercise the option order quantity in the call option contract scenario and then place an instant order with the manufacturer if necessary. In each scenario, the manufacturer and the retailer make their decisions simultaneously (static game) to determine the retailer’s optimal ordering and pricing policies and the optimal production quantity of the manufacturer (Nash equilibrium) by maximizing their expected profits. Finally, the impact of the model parameters on the supply chain is expressed through numerical examples. The numerical analysis shows that the call option contract provides greater profit than the wholesale price contract.

An emergency supplies procurement strategy based on a bidirectional option contract

The occurrence of a disaster and its location, type, intensity, scope and duration are highly uncertain, making it hard to accurately estimate the emergency demand. As the main purchasers and managers of emergency supplies, governments face shortage and surplus risks when pre-purchasing and reserving emergency supplies before disasters occur. To address this dilemma, we design an emergency supplies procurement strategy based on a bidirectional option contract (BOC) by considering the system as a relief supply chain. Expected profit functions of the relief supply chain members include the procurement cost, inventory cost and production cost of emergency supplies, the cost and revenue of option trading, the salvage value and the value of demand satisfaction. We derive the purchaser’s optimal procurement portfolio and demonstrate that the BOC enables the coordination of the relief supply chain. We illustrate the superiority of the BOC procurement strategy over the benchmark procurement scenario without the use of the BOC. As an extension, we also compare the BOC with two unilateral option contracts in emergency supplies procurement and summarise the advantage of the BOC. The research extends the application context of the BOC and provides a feasible strategy for governments to procure emergency supplies.

Option Contracts in Fresh Produce Supply Chain with Freshness-Keeping Effort

This study investigates a supply chain of fresh produce with consideration of option contracts and where stochastic market demand depends on freshness-keeping effort. Firstly, we investigate a benchmark scenario of an integrated supply chain with freshness effort and consideration of decreases in both the quality and quantity of produce while in the supply chain. Secondly, we introduce call, put, and bidirectional option contracts to mitigate risks of the retailer. A call option contract can reduce the underage risk, while a put option contract can reduce the overage risk, and a bidirectional option contract can reduce bilateral risks. We derive the optimal ordering decisions and freshness-keeping effort for a retailer in a supply chain of fresh produce with option contracts, and the conditions for achieving coordination of the supply chain. We find that the bidirectional option results in the highest option price and lowest option order quantity, while the call option results in the lowest initial order quantity and the put option results in the highest initial order quantity. Finally, numerical examples are given to demonstrate the impacts of various parameters on optimal decision-making. This paper provides managerial insights for reducing risk in fresh produce supply chains.

Optimization and coordination in a service-constrained supply chain with the bidirectional option contract under conditional value-at-risk

<p style='text-indent:20px;'>This paper investigates the optimal operational decisions for the risk-neutral supplier and the risk-averse retailer in the supply chain with a service requirement under the conditional value-at-risk. Specifically, the optimal order and production policies with and without the bidirectional option contract are derived. Further, this paper shows that the optimal conditional value-at-risk of the retailer is non-increasing in the service requirement, while the optimal expected profit of the supplier is non-decreasing in the service requirement. When the service requirement is binding, the optimal conditional value-at-risk of the retailer is increasing in the risk aversion, while the optimal expected profit of the supplier is decreasing in the risk aversion. In addition, it is shown that with the bidirectional option contract, the service level provided by the retailer is equivalent to (higher than) that without them when the service requirement is (not) binding. Finally, this paper demonstrates that the bidirectional option contract can mitigate the effect of risk aversion on the retailer's order quantity, benefit both the retailer and supplier, and improve the performance of the supply chain. Numerical experiments are conducted to further confirm our results.</p>

Bidirectional option contract for prepositioning of relief supplies under demand uncertainty

The demand for relief supplies after a sudden disaster is uncertain and sometimes grows rapidly. Because of the uncertainty surrounding the demand, organisations dealing in relief management usually preposition relief supplies to reduce the impact of a disaster. However, with prepositioning, organisations face both overstocking and stockout risks. To reduce these risks, we introduce a bidirectional option contract (BOC) into a two-echelon relief supply chain consisting of a supplier and a humanitarian organisation (HO). We analyse the contract from the perspective of the HO and derive closed-form expressions for the prepositioning quantity and options quantity for the HO, considering uniform and exponential demand distributions of relief supplies. The condition for supply chain coordination between the supply chain members is derived. We compare the results of BOC with the benchmark wholesale price contract (WPC) to show the superiority of BOC. Finally, sensitivity analysis is performed to investigate the impact of model parameters and to determine the conditions under which the BOC is beneficial for both the HO and the supplier.

Multiperiod Portfolio Procurement Problem With Option Contracts

A multiperiodic structure always underlies the procurement problem in practice. Option contracts are widely used to make a firm capable of responding flexibly to high demand uncertainty. However, so far, the impact of different option contracts on the multiperiod decisions and performance of a firm has been not discussed. Motivated by this problem, in this paper we analyze the multiperiod procurement problem within the framework of wholesale price, call, put, and bidirectional option contracts. Based on the dynamic programming theory, we characterize the structure of the firm's optimal replenishment policy for each period in four cases. We then develop a heuristic to approximate the corresponding policy parameters. Through system comparisons of four cases, we examine the value of option contracts for the firm and discuss the best option contract type for the firm. The results show that the firm will gain higher profits after the option contracts are introduced. Moreover, if the unit purchase and exercise costs of the bidirectional option are equal to those of the unilateral option, then bidirectional option contracts are preferred over unilateral option contracts. If the unit purchase cost of the bidirectional option is higher than that of the unilateral option, unilateral option contracts may be more profitable than bidirectional option contracts. Furthermore, if the unit backlogging cost is high and the unit inventory holding cost is low, call option contracts are better than put option contracts; if the unit backlogging cost is low and the unit inventory holding cost is high, then put option contracts work better than call option contracts.

Sustainability on the Service Capacity in Elderly Healthcare Service Supply Chains: An Application of Flexible Contracts

This article concerns the channel coordination of a two-echelon elderly healthcare service supply chain consisting of an elderly service integrator and a service provider to satisfy uncertain demand. Such channel coordination is achieved using a loss-sharing contract embedded with options, and the optimal service capacity and service sales effort are derived under a game-theoretic model. Results show that the loss-sharing contract, if used alone, cannot coordinate the supply chain effectively, and it needs to be combined with some options to achieve desired channel coordination. For the case of put option contract, the elderly service integrator will order the maximized service capacity initially. This is however, in contrast with the case of the bidirectional option contract where the integrator will order the minimized service capacity at the highest option price. Several managerial implications of the results are discussed, and some suggestions for implementation of the flexible coordination mechanisms for the government are provided.

Unmanned vehicle distribution capacity sharing with demand surge under option contracts

Big promotions of online retailers in different shopping festivals often lead to an overwhelming demand surge in parcel delivery. Besides using its own distribution capacity, online retailers usually adopt capacity sharing to cope with the demand surge. Because of the low cost of unmanned distribution, online retailers can adopt unmanned vehicle distribution (UVD) capability sharing. We examine an online retailer’s UVD capacity sharing strategies with a logistics firm under demand surge. We develop sharing models under the unilateral and bidirectional option contracts, from which we derive the optimal ex-ante and ex-post sharing strategies and the corresponding initial, option, and total sharing quantities. We find that if the online retailer wants to secure more UVD capacity in advance, it should use the bidirectional option; otherwise, the unilateral option. Moreover, both the initial sharing and total sharing quantities under the unilateral option are greater than those under the bidirectional option, which however can increase the flexibility of the online retailer. We conduct numerical studies to ascertain the effects of the model parameters on the optimal outcomes. The numerical results show that the degree of demand fluctuation has a greater impact on the initial and total sharing quantities under the unilateral option, and has a greater impact on the option sharing quantity under the bidirectional option. Finally, comparing self-built UVD capacity and UVD capacity sharing, we generate insights to provide guidance for the operations of online retailers.

Bidirectional options in random yield supply chains with demand and spot price uncertainty

This article develops a game-theoretic model to value the bidirectional option in a one-manufacturer and one-component-supplier system. The production process of the supplier is subject to random yield. The manufacturer contracts the supplier with bidirectional options to obtain components, and assembles them into end products to meet a stochastic demand. In addition, both firms can sell or/and buy the components on a spot market. First, the unique optimal order and production strategies of the decentralized system under bidirectional option contracts are derived. Second, resorting to numerical example and comparing the bidirectional option model with the call option model, we find that the manufacturer’s optimal firm and total order as well as expected profit under bidirectional options are larger than that of under call options, but the option quantity has the opposite tendency. The supplier’s optimal production quantity are larger under bidirectional options than that of under call options, but only when the option (exercise) price exceeds a certain value, the supplier’s expected profit under bidirectional options will be larger than that of under call options. Third, the coordination of the decentralized system under bidirectional option contracts is analyzed and a coordination mechanism with the contract is designed.

Fresh produce price-setting newsvendor with bidirectional option contracts

<p style='text-indent:20px;'>This paper examines a newsvendor problem for fresh produce with bidirectional option contracts, in which the stochastic demand is price-dependent. The bidirectional option, which may be exercised as either a call or put option, provides the newsvendor the flexibility to increase or decrease the initial order after real demand is realized, respectively. The condition of the fresh produce may deteriorate during circulation. The optimal order and pricing decisions for the newsvendor are analytically derived with the bidirectional option and circulation loss. Comparative statics analysis show that the optimal total order quantity and optimal retail price of the newsvendor decrease with the option price but increase with the exercise price. In addition, numerical examples show that the optimal total order quantity and optimal retail price of the newsvendor increase with the circulation loss. The optimal option order quantity first decreases then increases with the exercise price. The optimal firm order quantity first increases then decreases with the circulation loss. The maximum profit of the newsvendor decreases with the option price and circulation loss but increases with the exercise price. Furthermore, the values of bidirectional option contracts are more significant when the demand uncertainty and the circulation loss become more volatile.</p>

Supply Chain Coordination Investigation using a Bidirectional Option Contract: The Case of Unrealized Demand

This research considers a simple two-stage supply chain comprised of a distributor and a supplier. A bidirectional option supply contract was applied to deal with the problems of volatile demand, a long lead time, and a short selling season for a single type of product. The main research objective was to investigate whether this supply contract helps coordinate the supply chain in the case where demand is unrealized at the beginning of the selling season. It was found that, in the case of unrealized demand, this supply contract could not help coordinate the supply chain. On the contrary, comparing with the case demand was assumed as a realization at the beginning of the selling season (as in the existing literature), the supply contract helped coordinate supply chain.

Emission abatement and procurement strategies in a low-carbon supply chain with option contracts under stochastic demand

With the development of low-carbon economy, we discuss the decisions of carbon emission abatement and order quantity in a supply chain consisting of one manufacturer and one retailer under the stochastic demand. We analyze the models in the centralized and decentralized scenarios to find that the profits of all participants are improved, and carbon abatement can be increased. We further propose a unidirectional option (UO) contract contracts and a bidirectional option (BO) contract to coordinate supply chain members and analyze their different impacts on members. The results show that both contracts can effectively improve corporate profits and curb carbon emissions, but the UO contract is more beneficial to manufacturer, while the BO contract is more beneficial to retailer and the whole supply chain as well as the environment owing to its flexibility to cancel or return products not exceeding the option order quantity. Further, the numerical examples are given to analyze the influences of the retail price, wholesale price and demand volatility on the optimal strategies of all participants. Specially, we observe that option contracts have strong applicability, and if cooperating with option contracts, firms should pay more attention to the value of option price than the exercised option price.

Option ordering and coordination strategies for a two-periodsupply chain

PurposeDue to rapid product obsolescence, there is a significant decline in the market prices, which causes that the sale season is often divided into two periods. This paper aims to consider a class of two-period supply contracts that offer the retailer the ordering flexibility in response to the market changes. This paper analyzes the two-period ordering and coordination problem with option contracts.Design/methodology/approachThe authors incorporate call, put and bidirectional option contracts into the two-period ordering model. By applying stochastic dynamic programming, the authors derive the retailer’s optimal ordering policies for two periods. By benchmarking the case without option contracts, they highlight the advantage of option contracts. Through the mutual comparisons, the authors also explore the impacts of different option contracts. On this basis, the authors explore the conditions on which two-period supply contracts containing options can coordinate the supply chain.FindingsThis study shows that the retailer is always better off with option contracts. In addition, the effectiveness of different option contracts depends on the option contract parameters. When the parameters are the same for different option contracts, bidirectional option contracts are superior to call and put ones; otherwise, bidirectional option contracts might be superior or inferior to call and put ones. If designed properly, two-period supply contracts containing options can coordinate the two-period supply chain.Originality/valueThis paper is the first to highlight the value of option contracts as well as explore the role of different option contracts on the two-period procurement problem. The insights derived from our analysis can provide a good way on how to help the retailer work more efficiently in a two-period setting.

The impact of customer returns and bidirectional option contract on refund price and order decisions

This study investigates the impacts of customer returns and a bidirectional option contract on a newsvendor firm's refund price and order decisions. The stochastic demand is refund price-sensitive. We show that the optimal refund price increases with the option price and decreases with both the wholesale and exercise prices, while the optimal order quantity increases with the exercise price, but decreases with both the wholesale and option prices. Furthermore, we illustrate that in the presence of customer returns, the optimal refund price and order quantity decrease; the firm should cut the refund price and order more products if a bidirectional option contract is available. We identify the conditions under which a firm should offer a full, partial, or no refund policy. We also show that a bidirectional option contract can reduce the negative impact of customer returns and enhance the firm's profit, especially under high demand uncertainty.

Multi-period dual-sourcing replenishment problem with option contracts and a spot market

PurposeThe spot market has been gradually recognized as an important alternative purchasing source. To maintain a flexible replenishment strategy, call, put and bidirectional option contracts, as a risk hedging, are in combined usage with the spot market, respectively. The purpose of this paper is to analyze a finite-horizon replenishment problem with option contracts in the context of a spot market.Design/methodology/approachBased on stochastic dynamic programming, the firm’s optimal replenishment policy with either call, put or bidirectional option contracts is always shown to be order-up-to type, characterized by an upper threshold and a lower one. The corresponding policy parameters in different cases are calculated through an approximate algorithm. This research highlights the effectiveness of option contracts on the firm’s operational strategies and overall profitability.FindingsThis study reveals that the firm is better off with option contracts than without them. When the price parameters are the same for different option contracts, bidirectional option contracts are the best choice among these flexible contracts; otherwise, unilateral option contracts might be either better or worse than bidirectional ones. In addition, if low inventory costs and high spot price volatility are confronted, the firm prefers to call option contracts rather than put ones; otherwise, there exists an opposite conclusion.Originality/valueIn addition to highlight the advantage of option contracts over wholesale price contracts, this paper provides interesting observations with respect to the effect of different option contracts on the firm. Many significant insights derived from this research do not only contribute to the provider’s feasible design of the supply contracts, but also contribute to the user’s rational operational strategies for higher profitability.

Multiperiod Production and Ordering Policies for a Retailer-Led Supply Chain through Option Contracts

This paper formulates two groups of multiperiod production and ordering models with call and bidirectional option contracts for a two-party supply chain consisting of one followed supplier and one dominant retailer, respectively. Based on dynamic programming theory, we characterize the optimal policy structures for two partners in each period. We also provide an approximation for the corresponding policy parameters evaluation in two cases. Then, we investigate the impacts of different option contracts and the demand risk on the decisions and performances of two members. Our results suggest that, whether concerning call or bidirectional option contracts, the optimal policies for two members always follow a base stock type. When the price parameters are the same for different option contracts, the service levels of both the system and the retailer are higher with call option contracts than with bidirectional ones, whereas the retailer’s inventory risk is lower with bidirectional option contracts than with call ones. Under the same conditions stated above, call option contracts can always benefit the supplier, but not the retailer. Owing to the retailer’s dominant position, call option contracts are better choice for the supply chain if the option (exercise) price is low (high), while bidirectional option contracts are more suitable choice for the supply chain if the option (exercise) price is high (low). In addition, an increase in the demand risk would prompt the supplier to increase his production quantity and the retailer to reduce the initial firm order quantity, either with call or bidirectional option contracts.

Flexibility and coordination in a supply chain with bidirectional option contracts and service requirement

Option contracts have been increasingly employed by supply chain firms as a popular strategy to hedge against the risk of unanticipated demand. This paper examines the impact of bidirectional option contracts on a two-echelon supply chain consisting of a supplier and a retailer taking into consideration of a service requirement. We characterize the optimal solutions for the retailer and the supplier with and without bidirectional option contracts in the presence of a service requirement. By benchmarking to the model without bidirectional options, we explore the effect of bidirectional option contracts on the supply chain. Our study shows that the service level with bidirectional option contracts is equivalent to (higher than) that without them when the service requirement is (not) binding. In addition, bidirectional option contracts are indeed beneficial to both the retailer and the supplier. Furthermore, by investigating the effect of the service level on the supply chain, we find that the maximum expected profit of the retailer is non-increasing in the service requirement while that of the supplier is non-decreasing in the service requirement, either with or without bidirectional option contracts. Finally, a distribution-free coordination condition is proposed to achieve the Pareto improvement in the presence of bidirectional option contracts and a service requirement.

Call, put and bidirectional option contracts in agricultural supply chains with sales effort

This paper develops option contracts in a supplier-retailer agricultural supply chain where the market demand depends on sales effort. First, we examine a benchmark case of integrated supply chain with the loss rate. Second, we introduce three coordinating option contracts led by the supplier to reduce the retailer's risk, where the call option contract can reduce the shortage risk, the put option contract can reduce the inventory risk and the bidirectional option contract can reduce the bilateral risk. We find that both the optimal initial order quantity and the optimal option quantity increase with the sales effort and the option price will balance the influence of the loss rate on supply chain coordination. Furthermore, the bidirectional option price is the highest while its option quantity is the least, and the put option initial order quantity is the highest. Third, we also consider an option contract led by the retailer to reduce the supplier's wholesale risk. Among the above four option contracts, we find that the option quantity led by the retailer is the highest. Finally, the numerical examples present the impact of the parameters on the optimal decisions, and provide practical managerial insights to reduce the different risk in the agricultural supply chain.

Outsource planning with asymmetric supply cost information through a menu of option contracts

AbstractThis paper investigates a supply contract design by a dominant manufacturer who faces a stochastic demand during a selling season. The manufacturer has several estimations of the supplier's cost with corresponding probabilities, that is, asymmetric cost information. The manufacturer designs a menu of call option contracts that include three variables: a supply order, an option, and an exercise price. We determine the optimal negative correlation between option and exercise prices as well as closed‐form formulas for the optimal supply orders. The results show that in the optimal menu of contracts either the option or the exercise price may be omitted from the menu, whereas the supply orders should always be customized for each supplier type. We show that in this problem, optimal profit assignment between contract partners under put and bidirectional option contracts is the same as call option contract studied. Numerical analysis including managerial insights is presented.