What Is A 'Greenshoe Option': Underwriting Agreement Underwriter

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What is a 'Greenshoe Option'

In security issues, a greenshoe option is an over-allotment option. In the context of


an initial public offering (IPO), it is a provision contained in an underwriting
agreement that gives the underwriter the right to sell investors more shares than
originally planned by the issuer if the demand for a security issue proves higher than
expected.

A green shoe option is a clause contained in the underwriting agreement of


an initial public offering (IPO). Also known as an over-allotment provision, it allows
the underwriting syndicate to buy up to an additional 15% of the shares at
the offering price if public demand for the shares exceeds expectations and
the stock trades above its offering price.

BREAKING DOWN 'Greenshoe Option'

Over-allotment options are known as greenshoe options because, in 1919, Green


Shoe Manufacturing Company (now part of Wolverine World Wide Inc.), was the first
to issue this type of option. A greenshoe option can provide additional price stability
to a security issue because the underwriter has the ability to increase supply and
smooth out price fluctuations. It is the only type of price stabilization measure
permitted by the Securities and Exchange Commission (SEC).

Price Stabilization

This is how a greenshoe option works:

 The underwriter works as a liaison (like a dealer), finding buyers for the
shares that their client is offering.
 A price for the shares is determined by the sellers (company owners and
directors) and the buyers (underwriters and clients).
 When the price is determined, the shares are ready to publicly trade. The
underwriter has to ensure that these shares do not trade below the offering
price.
 If the underwriter finds there is a possibility of the shares trading below the
offering price, they can exercise the greenshoe option.

For example, if a company decides to publicly sell 1 million shares, the underwriters
(or "stabilizers") can exercise their greenshoe option and sell 1.15 million shares.
When the shares are priced and can be publicly traded, the underwriters can buy
back 15% of the shares. This enables underwriters to stabilize fluctuating share
prices by increasing or decreasing the supply of shares according to initial
public demand.

If the market price of the shares exceeds the offering price that is originally set
before trading, the underwriters could not buy back the shares without incurring a
loss. This is where the greenshoe option is useful: it allows the underwriters to buy
back the shares at the offering price, thus protecting them from the loss.

If a public offering trades below the offering price of the company, it is referred to as


a "break issue". This can create the assumption that the stock being offered might be
unreliable, which can push investors to either sell the shares they already bought or
refrain from buying more. To stabilize share prices in this case, the underwriters
exercise their option and buy back the shares at the offering price and return the
shares to the lender (issuer).

Examples of Greenshoe Options

A famous example of a greenshoe option at work is the Facebook Inc. IPO in 2012.
In that case, the underwriters had agreed to sell 421 million shares of the company
at $38. The issue proved to be very popular and they exercised their greenshoe
option, effectively selling 484 million shares on the market.

In 2014, underwriters exercised their greenshoe option during the IPO for Alibaba
Group Holding Ltd., making it the largest IPO in history at the time, at $25 billion.

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