The underwriter's secret stabilisation lever.
A greenshoe option (formally: overallotment option) grants underwriters the right to sell up to 15% more shares than originally planned in an IPO. If the stock trades above the offer price, the underwriter exercises the option and buys the extra shares from the issuer at the offer price, pocketing the spread. If the stock falls, the underwriter buys shares in the open market to support the price, then lets the option lapse.
Overallotment = Base Offering Size × Up to 15%If a company plans to sell 10 million shares at $20 (raising $200M), the greenshoe allows underwriters to sell up to 11.5 million shares. The extra 1.5M shares are the overallotment. This creates a short position of 1.5M shares that the underwriter can cover either by buying in the market (if stock drops) or exercising the option to buy from the issuer (if stock rises).
Stock trades above offer price
Underwriter exercises the greenshoe — buys 15% extra shares from the company at the IPO price and delivers them. The company raises slightly more capital. The underwriter profits on the spread. Strong demand signal.
Stock trades near offer price
Underwriter may partially exercise the option or buy a mix of open-market shares and new shares. The stabilisation mechanism is actively working — watch for unusual volume at or just below the offer price.
Stock trades below offer price
Underwriter buys shares in the open market to defend the price, then lets the greenshoe option lapse. This limits downside to some extent but is a clear signal that demand at the offer price was weak. A broken IPO.
The greenshoe is why IPO stocks rarely fall more than ~10% in the first 30 days even when demand is soft — the underwriter is actively buying to protect their reputation. Once the stabilisation period ends (typically 30 days post-IPO), that support disappears. A stock that has been propped up by greenshoe buying can fall hard once the mechanism expires.
People assume underwriters only profit when the IPO pops. In reality, the greenshoe is structured so they make money whether the stock goes up or down — the short position they create is effectively a free option. The greenshoe doesn't mean the underwriter thinks the stock is great. It means they've engineered a position that profits regardless of direction.
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