Greenshoe Option

Tanganan Village - Bali Indonesia
Tanganan Village - Bali Indonesia

The greenshoe option, also known as the overallotment option, is a tool used by a company and a financial intermediary (the bookrunner) to stabilize the company shares price after an IPO.

The term comes from the Greenshoe Manufacturing Company, which used this technique for the first time, giving the intermediary who was following the listing process the chance to buy an additional quantity of shares at the issue price for the IPO; these shares would be sold in case of excessive demand.

A greenshoe is an option to buy shares issued by a company in the process of being listed to the benefit of the bookrunner who follows the operation, with a strike price equal to the share price at the IPO. Normally, these options have a 30-day expiration. The stabilization mechanism that takes effect with a greenshoe is based on the behavior of the intermediary who holds the option.

In fact, the intermediary charged with stabilizing the share price takes a long position on the option (as a holder), and in order to achieve the correct balance, a short position on the market, short selling a number of shares equal to that established in the greenshoe at a price very near to the offer price.

If the share price falls, the intermediary does not exercise the greenshoe option and buys the shares to close the short position and the security lending with the issuer. By doing so, demand is stimulated and, consequently, the price is kept steady. If, on the contrary, the share price rises, the intermediary exercises the option and issues new shares on the market, stopping or slowing the price upsurge.