Exploring the Payoff Mechanism of REDD+ Call Options: A Tropical Country Perspective

The risks associated with carbon credit transactions discourage private investment in Reducing Emissions from Deforestation and forest Degradation in tropical countries (REDD+) and reduce incentives for forest conservation in tropical countries. REDD+ call options have been proposed as a carbon trading mechanism that reduces uncertainty and attracts private investment. Meanwhile, assessing their rationale for tropical nations remains limited. This study evaluated the payoffs of REDD+ call option contracts from the perspective of tropical countries. Using the Black-Scholes model, we identified strike prices and option prices that offset the costs of REDD+. Then we simulated carbon prices with geometric Brownian motion to examine option payoffs. The revealed payoff suggests that tropical countries are prone to losses under the REDD+ call option, although it represents a rational investment strategy for corporations. A short straddle-like payoff diagram suggests limited benefits under high market volatility, while even low volatility also fails to make the mechanism attractive due to insufficient upfront payments. Robustness checks using a Merton jump–diffusion process also confirmed that these qualitative payoff patterns persist under more realistic carbon price dynamics. To increase the practical applicability, we proposed alternative strategies such as covered call options. The study concludes that REDD+ call options should be adopted cautiously and complemented by appropriate risk management measures.