Green Shoe Option
Imagine a highly anticipated movie is releasing, and the theater only has 100 seats. Suddenly, 500 people show up. To manage the crowd and keep ticket prices from skyrocketing on the black market, the theater manager quickly adds 15 extra folding chairs in the aisle. Conversely, if the movie is a flop and nobody shows up, the manager might buy back some tickets to keep the hall from looking empty.
In the stock market, this extra chair or buyback mechanism is called the Green Shoe Option (formally known as an Over-allotment Option). It is a legal clause in an IPO agreement that allows the company’s bankers to sell more shares than originally planned to keep the stock price stable. It gets its name from the Green Shoe Manufacturing Company, which was the first to use this trick in 1919.
Similar read: What is a Greenshoe Option IPO?
How the Green Shoe Option Works
When a company goes public, the stock price can be very jumpy. It might shoot up 50% because of hype or crash 20% because of panic. The Green Shoe Option acts as a stabilizer for the first 30 days after listing.
The 15% Rule
Under SEBI guidelines in India, a company can over-allot up to 15% of the original issue size. If the company is selling 1 Crore shares, they can actually sell 1.15 Crore shares to the public.
The Two Scenarios:
- Scenario A: High Demand (Price goes UP)
If the stock price jumps above the IPO price, the bankers exercise the option. They buy that extra 15% of shares from the company at the original IPO price and give them to the investors who had already paid for them. The company gets extra capital, and the market gets more supply to cool down the price. - Scenario B: Low Demand (Price goes DOWN)
If the stock price falls below the IPO price, the bankers do not buy shares from the company. Instead, they go into the open market and buy back the shares using the money they collected from the over-allotment. This buying pressure helps push the price back up toward the IPO level, protecting new investors from a crash.
Open Demat account - Begin your investment journey now!
Key Benefits of Green Shoe Option
- Price Stability: It prevents the stock from breaking (falling below the offer price) in the first month.
- Investor Confidence: Knowing a Stabilizing Agent is watching the price makes retail investors feel safer.
- Extra Capital: If the IPO is a huge hit, the company can raise up to 15% more money than they initially expected.
No Cost to Company: The bankers handle the buying and selling; the company only provides the extra shares if needed.