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FinanceProfessor.com
Green Shoe OptionGreen Shoe Option; this is an option granted to the investment banker in most IPOs that allows the IB to sell additional shares if market conditions warrant. (that is if the market price is higher than the issue price, the IB can go back to the firm and get more stock to sell at the offer price.) Thus, it is as if the firm has sold a call contract to the investment banker.
Investment bankers regularly sell more than the entire allotment of shares in an IPO (for example they sell 115% of the originally allotted shares. If the shares drop in the secondary market, the Investment banker will cover the short position by buying in the secondary market. If the shares rose in the secondary market from the offer price, the IB will cover the short position buy buying new shares with the Green Shoe Option from the firm.
An example of an investment banker using this Green Shoe Option can be found this week with the ADR issue of Dr. Reddy. (see Corporate section)
(For more on this see Ellis, Michaely, and O’Hara JF June 2000 or Aggarwal (same issue JF June 2000)
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