Coordination of supply chains with bidirectional option contracts

•We model the supply chain that deals with products having high demand uncertainty.•We characterize the optimal order strategies with bidirectional options provision.•We examine the feedback effects that come from bidirectional options provision.•We develop the bidirectional option contracts to coordinate the supply chain.

In this paper we develop a supply contract for a two-echelon manufacturer–retailer supply chain with a bidirectional option, which may be exercised as either a call option or a put option. Under the bidirectional option contract, we derive closed-form expressions for the retailer’s optimal order strategies, including the initial order strategy and the option purchasing strategy, with a general demand distribution. We also analytically examine the feedback effects of the bidirectional option on the retailer’s initial order strategy. In addition, taking a chain-wide perspective, we explore how the bidirectional option contract should be set to attain supply chain coordination.