Greenshoe Options: An IPO’s Best Friend

what is green shoe option with example

A greenshoe option allows the group of investment banks that underwrite an initial public offering (IPO) to buy and offer for sale 15% more shares at the same offering price than the issuing company originally planned to sell. The clause is activated if demand for shares is more enthusiastic than anticipated and the stock is trading in the secondary market above the offering price. If demand is weak, and the stock price falls below the offering price, the syndicate doesn’t exercise its option for more shares. This contract provision, which may be acted on for up to 30 days after the IPO, gets its name from the Green Shoe Company, which was the first to agree to sell extra shares when it went public in 1960.

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A well-known real life example of Greenshoe option occurred in Facebook Inc. 2012 IPO. Underwriting syndicate, headed by Morgan Stanley agreed with Facebook, Inc. for purchasing 421 million shares priced at $38 for each share, less 1.1% fees for underwriting. However, around 484 million shares were sold by underwriter to clients which was 15% above initial allocation. In the IPO statement, the green shoe mechanism allows underwriters to short shares in the issuance of registered securities at the issue price. The scope of operation of the green shoe mechanism is different, but it usually does not exceed 15% of the original circulation.

Meaning of greenshoe option in English

A greenshoe option, also known as an “over-allotment option,” gives underwriters the right to sell more shares than originally agreed on during a company’s IPO. These provisions can help underwriters meet higher-than-expected demand up to a certain percentage above the original share number. Some issuers prefer not to include greenshoe options in their underwriting agreements under certain circumstances, such as if the issuer wants to fund a specific project with a fixed amount and has no requirement for additional capital. 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.

what is green shoe option with example

For example, if an issuer offers 10 million shares in an IPO, the Green Shoe Option would allow the underwriter to purchase an additional 1.5 million shares. In the second instance, the opposite occurred; the stock underperformed, and prices fell. A recent example of a greenshoe option being used in an IPO occurred in July 2021 when Robinhood went public. During the popular trading platform’s IPO, it granted an over-allotment option to its underwriters, which included Goldman Sachs, J.P Morgan, Barclays, Citigroup, and Wells Fargo Securities. If the Investment Bank B exercises the call option, it will purchase shares from Company A’s shareholders at a pre-agreed price.

When the trading price of a public offering is lower than the issue price, the issue is called a “break”. This makes the stock will be considered by the customer to be unstable and unsatisfactory, which may further lead to the sell-off of shares and vacillate the purchase of stocks. 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 is mostly stated in the underwriting contract and therefore gives the underwriters or the syndicate so formed the freedom of issuing greater number of shares if the demand for the same is high enough.

Is Greenshoe Option Valid in India?

Additionally, it protects the investor from a sharp decline in the share’s price. However, it is always preferable and prudent to avoid relying on just one factor and to carefully read the company’s offer document to learn more about it before investing. You can also consult Agarwal corporate to improve your stock market knowledge and get detailed investment strategies. The likelihood is that these investors will sell their shares after the listing to cash in on their unexpected profit, which could result in a decline in the share price.

what is green shoe option with example

The reverse greenshoe option gives the underwriter the right to sell the shares to the issuer at a later date. It is used to support the price when demand falls after the IPO, resulting in declining prices. The underwriter exercises the option by buying back the shares in the market and selling them to its issuer at a higher price. Companies use this technique to stabilize their stock prices when the demand for their shares is either increasing or decreasing. The specific details of the allotment are contained in the IPO underwriting agreement between the issuing company and the underwriters. The underwriters, usually investment banks or brokerage agencies, can exercise the overallotment option if the demand for the shares exceeds the expected demand and the sale price is significantly higher than the offer price.


To stabilize prices in this scenario, underwriters exercise their option and buy back shares at the offering price, returning those shares to the lender (issuer). When the issue succeeds, the demand for shares leads to an increase in the price of the stock and remains above the price of the issue. If underwriters close their positions by buying shares on the open market, they will buy stocks at a higher price than they did when they shorted them, thus suffering losses. The green shoe mechanism can play a role in this case, in which the company gives underwriters the right to overbuy at the beginning, allowing them to overbuy up to 15 per cent of the shares at the original issue price. By exercising the green shoe option, the underwriter can close the position by buying the stock at the price of short selling, thus avoiding the loss.

The underwriter studied the market and competition, conducted overall research, and reached a share price of INR 30 per share for the 50,000 shares the company plans to list in the market. On the other hand, only certain investors typically have access to the IPO market, and a greenshoe option doesn’t necessarily change that. Greenshoe options are commonplace in IPOs in the U.S. today, and, as you’ll learn, you can easily find examples of them being used. The name “greenshoe option” comes from the IPO of the Green Shoe Manufacturing Company. When the company went public in 1963, it was the first to allow for an over-allotment option, now informally known as the greenshoe option. Bankers want to prevent a loss of trading value in the first few days after the IPO.

Examples of Greenshoe Option

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. The underwriter exercises the full option when that happens and buy at the offering price.

This is a problem as the underwriter needs to close the short position.The underwriter sold the shares at 10 and would have to buy them back at the higher price to deliver these shares to the investor (if it were to buy the shares on the market). 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. If the market price exceeds the offering price, underwriters can’t buy back those shares without incurring a loss. This is where the greenshoe option is useful, allowing underwriters to buy back shares at the offering price, thus protecting them their interests. The main purpose of the greenshoe option is to allow the underwriter and issuing company to receive more capital if the demand is higher than anticipated.

On one hand, it affects investors by increasing the number of shares available to purchase. This increased liquidity in the market could result in more investors being able to purchase the IPO stock. In this example, where the company had an over-allotment option for 15,000 additional shares, if the underwriters sold all 15,000 additional shares, then they could do a full exercise of the option. But if only an additional 10,000 shares were sold, then it would constitute a partial exercise.

  • This method aids businesses in maintaining share prices and ensuring the success of public offerings.
  • The Green Shoe Option allows the underwriter to purchase additional shares from the issuer at the offer price, usually within 30 days of the IPO.
  • A reverse greenshoe is a special provision in an IPO prospectus, which allows underwriters to sell shares back to the issuer.
  • This enables underwriters to stabilize fluctuating share prices by increasing or decreasing the supply according to initial public demand.

To boost share demand and build investor confidence in the company’s potential, underwriters can purchase some company shares on the open market. In both situations, the underwriter has a 30-day window in which they can buy or sell the shares. The Securities and Exchange Commission (SEC) allows underwriters to engage in naked short sales in a share offering. Usually, underwriters use short selling when they anticipate a price fall, but the practice exposes them to price increases as a risk. In the United States, underwriters engage in short selling the offering and purchasing it in the aftermarket to stabilize prices. While selling short exerts downward pressure on the stock’s price, this tactic may facilitate a more stable offering that ultimately leads to a more successful stock offering.

Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. It is provided without respect to individual investors’ financial sophistication, financial situation, investment objectives, investing time horizon, or risk tolerance. You should consider the appropriateness of this information having regard to your relevant personal what is green shoe option with example circumstances before making any investment decisions. Moomoo makes no representation or warranty as to its adequacy, completeness, accuracy or timeliness for any particular purpose of the above content. The greenshoe option assists businesses in reducing risk while presenting public issues. It allows the underwriter to buy and sell some shares to ensure that the share price will not fall below the issue price.

Example – Overallotment of Facebook’s IPO

It’s important to note that the profits in this situation are limited as the shares purchased back are at the offer price. However, the use of the Green Shoe Option has also been criticized for artificially propping up the price of the shares and distorting the market’s price discovery mechanism. Critics argue that the option can create a false sense of demand for the shares, leading to an overvaluation of the company’s stock and potential losses for investors who buy the shares at inflated prices. When Facebook held its IPO in 2012, it sold 421 million Facebook shares at $38 to the underwriters, which included a group of investment banks who were tasked with ensuring that the stocks get sold and the capital raised sent to the company. 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. This option alone increased Robinhood’s IPO proceeds by an additional $158.5 million.

For example, if a company instructs the underwriters to sell 200 million shares, the underwriters can issue if an additional 30 million shares by exercising a greenshoe option (200 million shares x 15%). Since underwriters receive their commission as a percentage of the IPO, they have the incentive to make it as large as possible. The prospectus, which the issuing company files with the SEC before the IPO, details the actual percentage and conditions related to the option. 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.

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. 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.

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