2006-07-26 07:48:39 · 3 answers · asked by jits 1 in Business & Finance ➔ Investing
The previous answer is almost corect. The greenshoe option is not there to help when demand is greater than expected. It is there to help when demand is less than expected. Otherwise, that answer is excellent.
The greenshoe option is only used to cover overallotments. When a company goes IPO, the investment banks oversell the issue by 15%. If demand is high, then the price surges (this often happens, because I-Banks underprice IPOs on purpose).
This might seem like a bad situation for the I-Bank -- since they are short 15% of the issue. But 30 days after the deal is done, they are able to exercise the option and cover their short position with new shares bought at the IPO price. They make no money on the trade -- since they sold at the IPO price and bought at the IPO price. However, they do make money on the fees associated with selling an extra 15% of the deal. This is usually 7% of the proceeds.
The I-Bank usally acts as a marketmaker for the stock. If there is no interest in the deal, then lots of people sell their shares. This would usually cause the price to drop. Instead, the I-Bank supports the price at (or near) the IPO price. This is one of the few times where price support is legal. Since demand is low, the I-Bank builds up its inventory. After 30 days, if they have a large inventory, they use it to cover their short position and do not exercise the greenshoe option.
The greenshoe option, therefore, transfers the risk associated with supporting the stock price after IPO from the I-Bank onto the issuing company.
The greenshoe option is fairly standard. In the US, there are usualy only one or two large IPOs done per year that do not include this feature.
The big lesson here -- I-Banks rarely lose money on these deals.
2006-07-26 08:12:15 · answer #1 · answered by Ranto 7 · 1⤊ 0⤋
It is a provision contained in an underwriting agreement which gives the underwriter the right to sell investors more shares than originally planned by the issuer. This would normally be done if the demand for a security issue proves higher than expected. A greenshoe option can provide additional price stability to a security issue, since the underwriter has the ability to increase supply and smooth out price fluctuations if demand surges too high. The term is derived from the fact that the Green Shoe Company was the first to issue this type of option.
2006-07-26 07:59:59 · answer #2 · answered by 4XTrader 5 · 0⤊ 0⤋
What has already been said is excellent.
2006-07-26 10:51:20 · answer #3 · answered by kearneyconsulting 6 · 0⤊ 0⤋