Understanding Greenshoe Options: What Every Investor Should Know

A GreenShoe option, also known as an over-allotment option, is a provision in an IPO (Initial Public Offering) underwriting agreement that allows the underwriters to buy up to an additional 15% of the shares at the offering price. This option helps stabilize the price of the new shares in the secondary market after the IPO.

Greenshoe Option

How it Works:

1. Initial Offering: A company offers a certain number of shares to the public.

2. Over-Allotment: Underwriters can sell up to 15% more shares than initially offered.

3. Exercise of Option: If demand is high and the share price rises, underwriters can exercise the Green Shoe option to buy the extra shares at the offering price, providing additional supply and stabilizing the price.

4. No Exercise: If the share price falls below the offering price, underwriters buy shares from the open market to cover their short position, supporting the price.

For Example:

Suppose Devansh Choksi & Co. is issuing 1 million shares in its IPO at ₹10 per share, and it has a Green Shoe option for an additional 150,000 shares. If the demand is high and the stock price rises to ₹12 after the IPO, the underwriters can exercise the Green Shoe option to buy the extra 150,000 shares at ₹10 and sell them at the market price, making a profit and stabilizing the stock price.

Historical Use:

The Green Shoe option was first used by Green Shoe Manufacturing Company (now known as Stride Rite Corporation) during its IPO in 1963. This practice has since become a standard feature in many IPOs to help manage the share price post-offering.

The Green Shoe option, named after its origin with Green Shoe Manufacturing Company, serves as a crucial mechanism in the IPO process by allowing underwriters to stabilize the stock price and manage market volatility. By providing the flexibility to purchase up to an additional 15% of the shares at the offering price, it helps accommodate high demand and mitigate the effects of price fluctuations post-IPO. This strategic tool not only supports the stock's initial market performance but also enhances investor confidence, making it a widely adopted feature in modern public offerings.