Abstract: In the case of a retailer with limited capital and default risk and suppliers providing commercial credit, this paper studies the application of option contracts to coordinate supply chain. The theoretical analysis shows that the financial constraints make the retailers inclined to buy options, and the amount of option purchase decreases with the increase of initial funds, and increases with the increase of the probability of default, but the optimal initial option output of a supplier is affected only by its shortage response capability; the poorer the ability to respond to shortages, the more likely suppliers are to produce all option purchases. Further study obtains the conditions of supply chain coordination and finds that the profit distribution of centralized supply chain cannot be realized. Finally, through numerical analysis, it is found that there is a positive impact of the initial funds and default probability on the profits of the suppliers and the overall supply chain, and the relevant management enlightenment is obtained.

Key words: supply chain coordination, option contract, capital constraint, trade credit, default risk