Multi-period binding freight contract using swing options

The truckload freight market is a critical component of the US transportation industry, yet freight contracts used in this market are considered non-binding. Most shippers are challenged with freight rejection problems and forced to source from the spot market. The swing option is an exotic option that allows the holder to purchase or sell a defined quantity of underlying assets. This study proposes the use of swing options as multi-period binding freight contracts between shippers and carriers and builds a fair valuation framework using a mean-reverting process for the freight rates, the Hull-White tree model, and dynamic programming. Numerical examples are given to explain the multi-period price behaviours of the swing option freight contract. Sensitivity analyses are conducted on several key model parameters to understand the impacts of model parameters on the price of the swing option freight contract. Moreover, the performance of six tendering strategies is compared under different market conditions, which helps shippers make informed decisions on purchasing or entering into swing option contracts. Our results show that the shipper in an existing freight contract with a high freight rate benefits the most by tendering to the spot market and purchasing the short-term call swing option freight contract at a low strike price.