Hedging against uncertain supply and demand using options in a single period framework

This paper considers the impact of an option contract for a retailer/buyer and a manufacturer/supplier, within a single-period newsvendor framework, with a random supply and a random demand that incorporates hedging possibilities through call and put options. We consider two cases. In Case 1, the retailer hedges against the uncertain supply and the uncertain demand and the manufacturer does not hedge. In Case 2, the manufacturer hedges against the uncertain yield and the retailer does not hedge. We particularly focus on deriving (a) the optimal price and order quantity decisions of the retailer, in terms of both the committed order quantity and the number of option contracts; (b) the optimal pricing decision of the manufacturer with full information about retailer´s decision parameters and hence its optimal decisions. Here the demand consists of a mean demand component that is price dependent and an additive error component which is uniformly distributed.