Greenshoe Option

Greenshoe Option: Definition and Overview

A greenshoe option (also called an over‑allotment option) is a provision in an IPO underwriting agreement that allows underwriters to sell more shares than the issuer originally offered if demand is strong. It is primarily used to stabilize the stock price and provide extra liquidity immediately after listing.

Key features:
* Typically permits up to 15% additional shares above the original offering.
* Usually exercisable for up to 30 days after the IPO.
* The only SEC‑permitted formal price‑stabilization tool for new issues.

How It Works

Underwriters initially sell the planned number of shares and may sell an additional over‑allotment (up to the specified limit). They then have two main choices depending on market behavior:

• If the stock trades above the IPO price: exercise the greenshoe to buy the extra shares from the issuer at the IPO price and cover their short position.
• If the stock falls below the IPO price: buy shares in the open market to cover the short position, supporting the price without increasing the issuer’s outstanding shares.

The issuer’s prospectus specifies the over‑allotment percentage and any conditions. Underwriters have an incentive to expand the offering because their fees are typically a percentage of the IPO proceeds.

Example calculation:
* Issuer sets 200 million shares; a 15% greenshoe allows up to 30 million extra shares (200M × 15%).

How Underwriters Use It

Underwriters use the greenshoe mainly to:
* Meet unexpectedly high demand by selling more shares.
* Stabilize downward pressure by covering shorts with market purchases.
* Exercise the option to cover shorts if the market price stays at or above the IPO price.

They may exercise the option fully, partially, or not at all, depending on market conditions.

Types of Greenshoe Options

• Full greenshoe: underwriters sell and (if needed) purchase the maximum extra shares authorized.
• Partial greenshoe: underwriters sell some—but not the full—amount of the available over‑allotment.
• Reverse greenshoe: the underwriter returns or sells extra shares back to the issuer (or otherwise adjusts outstanding shares per the agreement).

Real‑World Example

In 2012, Facebook’s IPO included a 15% greenshoe. The underwriting syndicate sold more shares than the initial allocation, creating a short position that could have been covered by exercising the greenshoe if the market price rose. When the share price fell below the IPO level, the syndicate instead bought shares in the market to cover the short and help stabilize the price without exercising the option.

What It Means for Investors

• Potentially more shares available at the IPO stage, allowing broader participation.
• Can reduce early trading volatility and help defend against sharp price declines.
• Does not guarantee price protection; it is a temporary stabilizing mechanism during the immediate post‑IPO period.

Origin of the Term

The term “greenshoe” comes from Green Shoe Manufacturing Company, which was the first to include this over‑allotment provision in its underwriting agreement.

Bottom Line

A greenshoe option is a common IPO tool that gives underwriters flexibility to expand an offering and stabilize its price shortly after listing. Typical terms allow up to 15% more shares and a 30‑day exercise window, helping issuers and underwriters manage demand and market volatility during the critical early trading period.