What is a Greenshoe Option in India?
A GreenShoe Option(GSO) is nothing but a clause contained in the underwriting agreement of an Initial Public Offering(IPO).
This option permits the underwriters to purchase up to an extra 15% of the shares at the offer price if public demand for the shares exceeds expectations and the share trades above its offering price.
The GSO is also known as an Over-Allotment Provision.
This option is primarily used at the time of IPO or listing of any stock to ensure a successful opening price.
Let us try to understand the relevance and significance of what is GreenShoe option from the investor’s point of view.
Once the IPO closes, the company has to get its stocks listed on the BSE or the NSE, or both.
The market regulator, the SEBI i.e. Securities and Exchange Board of India, has made it compulsory for a firm to list its shares within 6 days of the closure of the IPO.
A GSO allows the underwriter of an IPO to sell additional shares to the public if the demand is high.
GreenShoe Option with Example
Let’s take an example for more understanding,
if XYZ company decides to sell 5 million shares, the underwriters may exercise their greenshoe option and sell 6.5 million shares.
If the market price of the shares exceeds the offer price, the underwriters exercise the GSO to buy back,
Generally, 15% of the shares are at the offer price, so protecting them from the loss.
If the shares trade below the offer price, then to stabilize share prices,
the underwriters exercise their option and buy back the shares at the offer price and return the shares to the issuer.
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Types of GreenShoe Option
The number of shares an underwriter buys back determines whether it exercises a full or a partial over-allotment provision.
A full option occurs when an underwriter is not able to buy back any of the shares before the market price rises.
The underwriter will then exercise its full option and buy back shares at the IPO.
The underwriter can buy back only a few of the shares before the price rises.
The underwriter exercises it as a partial option to buy back shares without suffering loss.
A reverse option, allows underwriters to sell shares to the company at a set price in the future.
If the price falls, this clause would let an underwriter purchase shares at the market price and sell them to the issuer at a higher cost.
The GSO(over-allotment) reduces the risk for a company issuing new shares.
it’s allowing the underwriter to have buying power in order to cover short positions,
if the offer price falls, without the risk of having to buy shares if the price rises.
In return prospect, this keeps the share price stable, benefiting both issuers and investors.