What Is An IPO Green Shoe Option? IIFL Knowledge Center
What Is An IPO Green Shoe Option? IIFL Knowledge Center

It balances the demand-supply relationship and prevents a company’s shares from skyrocketing due to excessive demand. A company issues an IPO majorly to raise funds for its operations and generate more revenues. Before going public, the company must be ready for the Securities and Exchange Board of India (SEBI) regulations and the advantages and obligations of public shareholders. During this process, https://1investing.in/ initially owned private shares are converted into public shares, bringing the value of the current private shareholders’ shares to the public trading price. Typically, a Greenshoe option can be exercised by the underwriters within 30 days from the date of the initial offering. When an underwriter implements a partial one, it implies that they can buy back a part of the 15% shares in the market.

If the share price declines to $10 per share following the IPO, the underwriter could purchase shares at the market price of $10 and then exercise its put option to sell those shares back to the issuer at $20 per share. The underwriter would help soften the downward slide in the post-IPO stock price by buying in the open market. As an example, a company intends to sell one million shares of its stock in a public offering through an investment banking firm (or group of firms known as the syndicate), which the company has chosen to be the offering's underwriters. Stock offered for public trading for the first time is called an initial public offering (IPO). Stock that is already trading publicly, when a company is selling more of its non-publicly traded stock, is called a follow-on or secondary offering. It is very common for companies to offer the greenshoe option in their underwriting agreement.

  • The Greenshoe option helped to support the stock price during the early trading days when the price was volatile.
  • Most public investors have no clue about the impact of the overallotment of shares in the economy.
  • In the event of volatile share price fluctuations, price stabilisation becomes a boon for small-scale and retail investors.
  • The company was able to meet the demand by raising additional funds through the overallotment of its shares.

As a result, one of the qualities that investors look for in an offer contract is a greenshoe share option. To benefit from the demand for a company’s shares, the underwriters may execute the greenshoe option. When a famous company decides to go public and issue IPO, it will attract public investors to invest just with their popularity. In summary, the greenshoe option helps to provide price stability to a security issue by allowing the investment bank to increase the supply of shares if there is high demand and buy back shares if the demand is low. Since the demand for the shares is high, the share price increases to $25 per share, benefiting the investors who bought the shares at $20. The investment bank then uses the 1.5 million shares purchased from XYZ to cover their short position, thus stabilizing the share price.

In certain circumstances, a reverse greenshoe can be a more practical form of price stabilization than the traditional method. Is part of the IIFL Group, a leading financial services player and a diversified NBFC. The site provides comprehensive and real time information on Indian corporates, sectors, financial markets and economy. On the site we feature industry and political leaders, entrepreneurs, and trend setters.

What is the Greenshoe option in an IPO?

Recently, we have witnessed some big pops (for example, Airbnb, 113 percent first-day return) and some steep drops (Wish, negative 16 percent). Greenshoe option showed that the stabilising procedure could provide profits for underwriters of up to $100 million like earned by Morgan Stanley while stabilising the Facebook IPO. A private company generates growth with the help of a small number of investors, including founders, friends, family and professional investors like venture capitalists.

  • Oversubscription of the company’s shares allowed it to raise additional capital through overallotment to meet the demand.
  • For example, if a company decides to sell 1 million shares publicly, the underwriters can exercise their greenshoe option and sell 1.15 million shares.
  • To keep pricing control, the underwriter oversells or shorts up to 15% more shares than initially offered by the company.
  • Overallotments are sales by the underwriting syndicate in excess of the number of shares the syndicate is obligated to purchase to underwrite the offering.
  • As part of this option, the issue underwriters intervene in such cases and purchase some number of the company’s shares at a fixed price.

When participating in an IPO, the lead underwriter of the offering will typically assume the responsibility of ensuring the newly-listed security price remains within reasonable bounds in the weeks following the IPO. To accomplish this, the terms of the underwriting agreement will include a provision allowing the underwriter to buy or sell shares from the issuer in such a way as to dampen the volatility of the share price. The reverse option is when the underwriter sells the extra shares back to the issuing company. They usually execute this option when the demand drops or to stabilise the price when it becomes volatile.

Introduction to Green Shoe Option

The company went public at the end of July; at the end of August, Robinhood announced that its underwriters had partially exercised the greenshoe option, purchasing 4,354,194 shares of Class A common stock. A Greenshoe Option allows the underwriters to purchase additional shares in case of excess demand. In contrast, a Reverse Greenshoe Option allows the underwriters to buy shares in the open market and then return them to the issuer to prevent an oversupply of shares. A Greenshoe Option is a clause included in an underwriting agreement that allows the underwriting syndicate to buy up to an additional 15% of company shares at the offering price for a certain period after the offering. This is where the Greenshoe option kicks in – this allows the underwriter to buy the shares at an issue price (in this example 10) from the issuer. The issuer receives additional proceeds; the underwriter will have sold shares at 10, buying the shares at 10.

Guidelines for exercising green shoe option

The legal name is "overallotment option" because, in addition to shares originally offered, additional shares are set aside for underwriters. This type of option is the only SEC-sanctioned method for an underwriter to legally stabilize a new issue after the offering price has been determined. SEC introduced this option to enhance the efficiency and competitiveness of the IPO fundraising process. The term "greenshoe" arises from the Green Shoe Manufacturing Company, now known as the Stride Rite Corporation.

If we assume that the over allocation is set at 15% of the offering, this would amount to 15m extra shares. The underwriter does not have these shares to sell, so it effectively shorts the shares (sells shares it does not have). It owes these shares to the investors,and it must deliver these shares to the investors. The underwriter will need to obtain the shares from somewhere in order to close its short position. The company may get IPO proceeds from those additional 15m shares if the underwriter sources the shares from the issuer. The company had initially granted the underwriters the ability in the greenshoe clause to purchase from the company up to 15% more shares than the original offering size at the original offering price.

A green shoe option is the right of the underwriters to purchase an amount of shares in addition to and at the same price as the base shares in the IPO. Under the full greenshoe option, the underwriter exercises their option to repurchase the entire 15% shares from the company. They can weigh in on this option when they are unable to buy back any shares from the market. But as the shares of Facebook decline below the IPO price soon after the trading begins, short position was covered by underwriter without exercising greenshoe option for stabilizing the price and avoiding any steep fall in price. The Greenshoe Option benefits the underwriter by allowing them to sell more shares than originally planned if demand is high, or to buy back shares to support the price if the initial public offering does not go as well as expected. Therefore, we can conclude by saying that the green shoe option is used for over allotment of the number of share in excess of the stated number in the IPO or any other share issue process.

It grants underwriter a right to issue 15% additional shares than originally planned and it need to be exercised within the time period of 30 days of offering. When a company has an initial public offering of their shares, there is a chance that demand for these new shares will surge and cause undesirable price fluctuations. With the green shoe option, prices can be better stabilized because the underwriter has the permission to sell additional shares as needed, up to 15% more than the originally allocated amount. The definition of a reverse greenshoe option, also known as an overallotment option, is a provision used by underwriters in the initial public offering (IPO) process.

By exercising the greenshoe, the underwriters are able to close their short position by purchasing shares at the same price for which they short-sold the shares, so the underwriters do not lose money. The greenshoe option reduces the risk for a company issuing new shares, allowing the underwriter to have the buying power to cover short positions if the share price falls, without the risk of having to buy shares if the price rises. It allows the underwriting syndicate to buy up to an additional 15% of the shares at the offering price if public demand for the shares exceeds expectations and the stock trades above its offering price. The option of realizing either trading position effectively makes underwriters long a straddle at the initial offering price in IPOs. A greenshoe option is a provision in an underwriting agreement that gives underwriters the right to sell more shares than initially agreed on. Greenshoe options, also known as “over-allotment options,” are included in nearly every initial public offering (IPO) in the United States.

Risk disclosures on derivatives -

Alibaba Group Holding Limited (BABA) - In September 2014, Alibaba went public in the largest IPO in history. The underwriters of the IPO exercised the greenshoe option to purchase an additional 48 million shares from the company, bringing the total number of shares sold to 320.1 million. The Greenshoe option allowed the underwriters to stabilize the stock price during the volatile market conditions. The investment bank decides to exercise the greenshoe option and sell an additional 1.5 million shares, bringing the total number of shares sold to 11.5 million.

This can be especially important in cases where the demand for the stock exceeds the number of shares initially offered. If the underwriters are able to buy back all of the oversold shares at or below the offering price (to support the stock price), then they would not need to exercise any portion of the greenshoe. The number of shares the underwriter buys back determines if they will exercise a partial greenshoe or a full greenshoe. A partial greenshoe indicates that underwriters are only able to buy back some inventory before the share price rises. A full greenshoe occurs when they're unable to buy back any shares before the share price rises.


This can create the perception of an unstable or undesirable offering, which can lead to further selling and hesitant buying of the shares. To manage this situation, the underwriters initially oversell ("short") the offering to clients by an additional 15% of the offering size (in this example, 1.15 million shares). The underwriters can do this without the market risk of being "long" this extra 15% of shares in their own account, as they are simply "covering" (closing out) their short position. Increasing demand for a company’s shares can raise the share prices to a price above the offer price.

The purpose of the greenshoe option is to provide stability to the stock price in the event of increased demand for the shares after the IPO. The greenshoe option grants the underwriters the right to issue additional shares, up to 15% of the original shares issued, in case of excess demand. This helps to prevent the share price from skyrocketing and also provides the underwriters with an opportunity to buy back shares at the offering price, stabilizing the price. Alibaba IPO – When Alibaba went public in the U.S. in 2014, it had a greenshoe option in its favour.

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