Reverse Greenshoe Option: Meaning, Example, History

The main purpose of a Greenshoe Option is to stabilize the price of a security post its initial public offering (IPO) or secondary market offering. A reverse greenshoe is a special provision in an IPO prospectus, which allows underwriters to sell shares back to the issuer. From an investor’s perspective, an issue with green shoe option provides more probability of getting shares https://1investing.in/ and also that post listing price may show relatively more stability as compared to market. Green shoe is a kind of option which is primarily used at the time of IPO or listing of any stock to ensure a successful opening price. Any company when decides to go public generally prefers the IPO route, which it does with the help of big investment bankers also called underwriters.

As a result, one of the qualities that investors look for in an offer contract is a greenshoe share option.
Alibaba Group Holding Limited (BABA) – In September 2014, Alibaba went public in the largest IPO in history.
In such a case the underwriter or the issuer can buy back the shares at the offered price and reduce the number of shares offered, to stabilize the price.
The use of the greenshoe (also known as “the shoe”) in share offerings is widespread for two reasons.

These shares can then be sold to investors at the current market price, which helps stabilize the stock price. Conversely, if the demand for the shares is low and the stock price starts to fall, the underwriters can buy back the shares from the market to cover their short position and stabilize the price. The Greenshoe option primarily serves as a safety valve for companies during Initial Public Offering (IPO) or secondary offerings. Its main purpose is to provide stability and control to a company’s stock price after the offering.

Full, Partial, and Reverse Greenshoes

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). For example, if a company decides to sell 1 million shares publicly, the underwriters 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.

The option increases the role of investment bankers enabling them to protect small investors by price stabilisation in case the market price falls below the offer price.
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%).
SEC introduced this option to enhance the efficiency and competitiveness of the IPO fundraising process.
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.
Founded in 1919, Green Shoe was the first company to implement the so-called greenshoe clause into its underwriting agreement.

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. In June Coty raised $1bn through an initial public offering(IPO) as the beauty products group became the second largest consumer products company to float its shares on the US market during the past decade. As part of this issuance the underwriters of the IPO were allowed to short sell shares in Coty as a result of a Greenshoe or “overallotment” option. In a company prospectus, the legal term for the greenshoe is “over-allotment option”, because in addition to the shares originally offered, shares are set aside for underwriters. This type of option is the only means permitted by the US Securities and Exchange Commission (SEC) for an underwriter to legally stabilise the price of a new issue after the offering price has been determined.

green shoe option definition

In 2009, most realty companies in India, who were planning to raise funds from the primary market, had opted for green shoe option in their IPOs to stem volatility in share prices following their listing on the exchanges. However, such would not be the case if underwriters exercised this option and purchased additional shares at the initial offer price. The reason is that any loss sustained when the shares were trading below the offer price is balanced by the difference between the offer price and the current market price. The additional shares that can be issued through the greenshoe option can help to meet increased demand for the stock.

Meaning of Greenshoe Option

Overall, this made the IPO one of the largest in history, raising about $20.1 billion. Overallotment can also be used as a price-stabilization strategy when there is an increasing or decreasing demand for a company’s shares. When the share prices go below the offer price, the underwriters suffer a loss, and they can buy the shares at a lower price to stabilize the price. Buying back the shares reduces the supply of the shares, resulting in an increase in the share prices. For example, if a company decides to do an IPO of two million shares, the underwriters can exercise the 15% overallotment option to sell a total of 2.3 million shares.

Reasons for Overallotment / Greenshoe

The research, personal finance and market tutorial sections are widely followed by students, academia, corporates and investors among others. In case the newly listed shares start trading at a price higher than the offer price, the stabilising agent does not buy any shares. Before investing in an IPO, we go through the offer document of the company to know more about it. Lock-up agreements are not necessary at all in direct listings where Regulation M does not apply. Reputational forces undoubtedly constrain IPO pricing to at least some degree, but reputation may not be sufficient to prevent opportunistic trading by underwriters that is undetectable by issuers or the market. Thus, the blowouts in the Airbnb IPO and the flop in the Wish IPO are two sides of the same coin.

The Greenshoe option helped to support the stock price during the early trading days when the price was volatile. Using the greenshoe option, the underwriters can sell more shares than were initially offered through the IPO. This over-allotment provision typically allows the underwriters to sell up to 15% more shares at the agreed-upon IPO price and can be exercised up to 30 days after the IPO.

History of Greenshoe Option

By leveraging the Greenshoe option, underwriters are enabled to stabilize the price of shares as they can buy back shares at the offer price, thus preventing the share price from dropping below the offer price. Normally, underwriters are allowed to sell an additional 15% of the company’s shares on top of what has been initially offered. This extra allotment of shares released in the market can help satisfy the excess demand, maintain the stability of share prices during the post-IPO period and contribute to the overall success of an offering. This option helps stabilize the stock price in the secondary market by providing an additional supply of shares to meet the demand of investors.

In the universe of 911 U.S. commercial IPOs between 2010 and 2017, only 6 (1) percent of IPOs finished the first (tenth) day of trading with exactly a 0 percent return.

If a greenshoe option was exercised, then more shares entered the market than was originally planned. As a result, there are more shares outstanding that could potentially be available to you as an investor. A well-known example of a greenshoe option at work occurred in Facebook Inc., now Meta (META), IPO of 2012.

The SEC introduced this option to enhance the efficiency and competitiveness of the fund raising process for IPOs. Share prices may rise above the offer price due to increasing demand for a company’s shares. In this case, the underwriters cannot repurchase the shares at the current market price since they would suffer a loss. Repurchasing shares increases the share price since it decreases the supply of shares.

By providing a way to stabilize the stock price, it reduces the risk of underwriters being left with unsold shares, which could result in significant losses. However, if the share price drops below the offer price, the investment bank can purchase shares from the market to cover its short position, supporting the stock and stabilizing its price. Issuers may choose not to include greenshoe options in their underwriting agreements under certain circumstances, such as if they want to fund a specific project with a fixed amount and have no requirement for additional capital. As a company prepares to go public, it works with its underwriters to determine the number of shares to offer and the price at which to offer them. But in some cases, the demand for IPO shares may exceed the actual number of shares available.