What is a Greenshoe Option?

A greenshoe option is one of several rules regarding an Initial Public Offering (IPO) that helps a company or business to go public. The greenshoe option deals with being able to facilitate a stock value to stabilize price. There are several kinds of greenshoe options that underwriters, the people responsible for bringing the stock offering to market, can use to make sure that the stock is priced correctly.

When a company goes public, it does so with an initial public offering of stock. Investors can buy in at a defined stock price, but they often must hold the stock for a certain amount of time. This is called an IPO lock-up period. The rules of the lock-up period mean that the stock price is not allowed to fluctuate as it generally would on the common market.

In a greenshoe option, the underwriter can issue up to 15% more stock than the original offering if high demand is a problem. According to experts, using additional stock in a short sale can also help stabilize the stock price. What the underwriter does with the extra stock can help create a stock price that will resemble the initial offer price.

The greenshoe option is not named for anything concerning its literal application to an IPO. It is named for the Green Shoe Company, now known as Stride-Rite, that pioneered its use. Many companies involved in an IPO have since applied a greenshoe option in order to encourage growth during and after an initial public offering.

Partial, whole, or reverse greenshoe options are useful to those who have to do the work of shoring up the value of an IPO. In addition, other rules often affect an IPO, including a “quiet period,” where staffers of a company or business are prohibited from talking about the value of their stock for a certain amount of time. The Securities and Exchange Commission, the agency in charge of regulating the stock market, sets these rules to limit volatility and promote healthy trading.

The greenshoe option can help underwriters, or “stabilizers” deal with the effects of a red herring prospectus, which is a document issued before all of the fine print on an IPO is set in place. The greenshoe option can also be helpful in a “break issue” situation, where various factors lead to a stock's price sagging lower than the original offer price. Factors in a break issue can include lock of consumer faith in a product, an overall economic downturn, or the spread of rumors about a company.