Supply option contracts with spot market and demand information updating

Yingxue Zhao, Tsan Ming Choi, Edwin Tai Chiu Cheng, Shouyang Wang

Research output: Journal article publicationJournal articleAcademic researchpeer-review

57 Citations (Scopus)


Motivated by the industrial practices, this paper develops a two-stage model to explore the supply option contract in a two-echelon supply chain, taking into account a stochastic spot market and demand information updating of general correlation. We develop a concept called EUOS (expected unit opportunity saving) by which to examine the expected benefit received per unit of the option under different market scenarios. With the concept of EUOS, we develop intuitive analytical results to characterize the optimal strategies for portfolio procurement via the option contract and spot markets, and to design the appropriate option mechanism for supply chain coordination. Furthermore, we reveal that EUOS can be a viable alternative for real option pricing in the supply chain. Detailed comparisons between the mixed market scenario (in which the spot market and the option contract market co-exist) and the scenario with pure spot market or pure option contract market are made, and thereby we analytically examine the effects of supply competition between the spot market and the option contract market. Our paper contributes to the literature by developing intuitive characterizations for the option contract models and generating some new insights with respect to the use of supply option contracts in the supply chain in the presence of a stochastic spot market and demand information updating.
Original languageEnglish
Pages (from-to)1062-1071
Number of pages10
JournalEuropean Journal of Operational Research
Issue number3
Publication statusPublished - 1 May 2018


  • Demand information updating
  • Option contract
  • Spot market
  • Supply chain contract
  • Supply chain management

ASJC Scopus subject areas

  • Modelling and Simulation
  • Management Science and Operations Research
  • Information Systems and Management

Cite this