how a greenshoe option works
a greenshoe option provides additional price stability to a security issue because the underwriter can increase supply and smooth out price fluctuations 1 it is the only type of price stabilization measure permitted by the securities and exchange commission sec 23greenshoe options typically allow underwriters to sell up to 15 more shares than the original amount set by the issuer for up to 30 days after the ipo if demand conditions warrant such action 1 for example if a company instructs the underwriters to sell 200 million shares the underwriters can issue 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 over allotment options are known as greenshoe options because green shoe manufacturing company now part of wolverine world wide inc www as stride rite was the first to issue this type of option 1underwriters use greenshoe options in one of two ways first if the ipo is a success and the share price surges the underwriters exercise the option buy the extra stock from the company at the predetermined price and issue those shares at a profit to their clients conversely if the price starts to fall they buy back the shares from the market instead of the company to cover their short position supporting the stock to stabilize its price 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 underwriters can choose to either fully or partially exercise the option example of a greenshoe optionfacebook inc now meta meta agreed to a greenshoe option when it listed its shares in 2012 the underwriting syndicate headed by morgan stanley ms agreed with facebook to purchase 421 million shares at 38 per share less a 1 1 underwriting fee however the syndicate sold at least 484 million shares to clients 15 above the initial allocation effectively creating a short position of 63 million shares 45if facebook shares had traded above the 38 ipo price shortly after listing the underwriting syndicate would ve exercised the greenshoe option to buy the 63 million shares from facebook at 38 to cover their short position and avoid having to repurchase the shares at a higher price in the market however because facebook s shares declined below the ipo price soon after it commenced trading the underwriting syndicate covered its short position without exercising the greenshoe option at or around 38 to stabilize the price and defend it from steeper falls 