Green Shoe Options

Green shoe option (GSO) is a legalized price stabilizing measure which is often used by the companies in their IPO's so as to stabilize the price of the shares in the post-listing period. The name comes from the fact that green shoe manufacturing company(stride rite corporations) was the first to implement it in it's IPO. It is a provision written in the underwriters agreement which allows the underwriters to overallot the shares upto the extent of 15% of the total IPO size.

Under this option, stabilizing agents are appointed by the company, and the promoters or pre-issue shareholders who owns more than 5% of the shares of the company can lend their part of shares to these agents for the purpose of overallotment. While following the book building process, if a company receives exceptionally heavy demand over and above its IPO size, it opens a GSO bank account and transfer the excess money in that account. The shares are alloted to these applications from GSO demat A/c on pro-rata basis. In this manner, shares are alloted to maximum shareholders and probability of shareholders being dissatisfied is reduced.

HOW GREEN SHOE WORKS

After the share is being listed in the secondary market, the stabilizing agents have to return the over-alloted shares to the promoters within 30 days of listing (stabilizing period). Green shoe option is a physically settled call option given to the underwriter by the issuer. If the share price increases, then the stabilizer simply cover his short position at the strike price. However if the share price falls, then short position is covered through open market and stabilizer also manages to earn profit.

REVERSE GREEN SHOE OPTION

A reverse green shoe is a special provision in an IPO prospectus, which allows underwriters to sell shares back to the issuer. If a regular green shoe, is in fact, a call option written by the issuer for underwriter, then reverse green shoe is a put option. In this case, if the share price falls, then stabilizer buy the shares from the open market and sell those shares exercising put option, thus stabilizing the price by using volume. However, in case their is a rise in prices, the situation is left untouched. And in case the stabilizer is unable to cover his position within the stabilizing period, the company has to issue shares upto that amount and the residue at GSO bank A/c is then transfer to the Investor Protection Fund.

Green shoe option worked in the case of Alibaba as it managed to became the biggest IPO by exercising this option and raising $25 billion ($3.2 billion excess). However, the option proved a failure in case of facebook ipo where the prices were not stabilized even for a day.

Green shoe option being technical in nature is perfect for a company which desires to enter the market with stable prices. However, if the company wants to raise a specific amount of funds, then it is least interested in using these type of mechanism. As a conclusion, we can say that green shoe option is a mechanism which bears potential of hedging the risk for a new company in raising its IPO. It's fast growing use by various companies reveals about it's utility. Even though some modifications are still required in this area, but green shoe option has proved itself to be a perfect mechanism for a flipper market. 

-Samriddhi Singhal