Reverse Greenshoe Option

What Is a Reverse Greenshoe Option?

The definition of a reverse greenshoe option, otherwise called an overallotment option, is a provision involved by underwriters in the initial public offering (IPO) process. It is expected to give increased price stability to the recently recorded security.

Reverse greenshoe options are like regular greenshoe options then again, actually they are structured as put options as opposed to call options. In the two cases, notwithstanding, their objective is to advance price stability following the IPO.

Figuring out Reverse Greenshoe Options

While participating in an IPO, the lead underwriter of the offering will typically take on the obligation of guaranteeing the recently recorded security price stays inside reasonable limits soon after the IPO. To achieve this, the terms of the underwriting agreement will incorporate a provision permitting the underwriter to buy or sell shares from the issuer so as to hose the volatility of the share price.

In a common greenshoe option, this is finished by utilizing a call option written by the issuer or primary shareholder(s) that permits the underwriter to buy a given percentage of shares issued at a lower price to cover a short position taken during the underwriting.

Paradoxically, a reverse greenshoe option comprises of a put option written by the issuer or primary shareholder(s) that permits the underwriter to sell a given percentage of shares issued at a higher price should the market price of the stock fall.

The Securities and Exchange Commission (SEC) acquainted this option with improve the proficiency and seriousness of the IPO raising money process.

Illustration of Reverse Greenshoe Option

For instance, assume an IPO price is set at $20 per share, and the underwriter is given a "reverse greenshoe" put option with a strike price of $20 per share. In the event that the share price declines to $10 per share following the IPO, the underwriter could purchase shares at the market price of $10 and afterward exercise its put option to sell those shares back to the issuer at $20 per share. The underwriter would assist with relaxing the descending slide in the post-IPO stock price by buying in the open market.

History of Reverse Greenshoe Option

The term "greenshoe" emerges from the Green Shoe Manufacturing Company, presently known as the Stride Rite Corporation. Established in 1919, Green Shoe was the principal company to execute the supposed greenshoe clause into its underwriting agreement. Technically, this clause's legal name is an "overallotment option" in light of the fact that, notwithstanding the shares initially offered to them, extra shares are set to the side for underwriters. This option is the main way an underwriter can legally balance out another issue in the wake of determining the offering price.

Features

• A reverse greenshoe option is a method utilized by IPO underwriters to reduce the volatility of the post-IPO share price.
• The subsequent buying pressure from the underwriter is expected to help relieve against a descending slide in the share price.
• It includes utilizing a put option to purchase shares in the open market and sell them back to the issuer at a higher price.