Optimal ordering policy for a price-setting newsvendor with option contracts under demand uncertainty

Abstract

In this article, we investigate the newsvendor problem in a joint ordering and pricing setting in the presence of option contracts under demand uncertainty. At the beginning of a single selling season, the newsvendor who faces additive stochastic demand can obtain goods through two ways: ordering from a firm or purchasing and exercising call options. Single ordering (ordering from a firm only or purchasing and exercising call options only) and mixed ordering (ordering from a firm and purchasing and exercising call options simultaneously) cases are investigated. We find that the newsvendor’s optimal pricing and ordering strategies exist and are unique for both cases, respectively. In addition, when both cases are available, mixed ordering is the newsvendor’s optimal ordering policy. If only single ordering is available, the newsvendor prefers ordering from a firm when demand risk is low, while enjoys purchasing and exercising call options when demand risk is high. We also find that with option contracts, the newsvendor’s optimal order quantity and maximum expected profit are all decreasing in the option price and exercise price of product, while the optimal retail price in terms of option price and exercise price of product are intricate. Moreover, we show that, mixed ordering is more capable to deal with supply price volatility risk.

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