Risk analysis of supply contract with call options for buyers

Abstract Flexible supply contracts with options have been proposed to supply chains with long lead-times, short selling seasons and high demand uncertainties to improve the performance. In this paper, we analyze the risks of introducing options, and find that even if providing a higher expected profit at the beginning of a planning horizon, supply contracts with options may have risks associated with a worse performance later compared with the traditional newsvendor contract model. We derive two important parameters for the buyer to estimate the risks of introducing options. One is a risk indicator that can show whether using options-based contract model has risks or not, and the other is a ratio to measure the probability of such risks.