When to introduce options and when not to: a portfolio contract perspective

Abstract Previous studies in operations management have extensively focused on how options positively affect supply chain profits in stochastic environments. In this study, we investigate when options are an appropriate strategy to follow from a new perspective of portfolio contract in the presence of random spot prices. In this setting, an instant purchase mechanism is considered to address overproduction once demand is realized. Specifically, we examine a novel portfolio contract that includes the instant purchase mechanism, wholesale contract, and option contract, taking into account uncertainties in demand and spot price. We also explore the two alternative portfolio contracts: one excluding the option contract (wholesale‐based contract) and the other excluding the wholesale contract (option‐based contract). Our results show that the presence of the instant purchase mechanism may impede the adoption of options during periods of overproduction. That is, options may not always provide benefits to supply chains. However, options prove beneficial in situations where overproduction is absent. Additionally, the instant purchase mechanism diminishes the positive impact of options when confronted with significant demand uncertainty. Surprisingly, the value of options becomes apparent in situations of low demand uncertainty, especially in the case of option‐based contracts, and also becomes evident as spot price uncertainty increases. Finally, we extend the model framework by studying the random unit revenue of final products and the uncertain exercise price. Our results also provide timely implications for when supply chains could possibly introduce options.