What Is the Greenshoe Option?

The greenshoe option is a feature that allows an underwriter of a particular security to sell more shares than what was originally discussed. Here are the basics of the green shoe option and what it means to investors.

Greenshoe Option

When an individual underwriter is selling a particular security, they really do not have any idea how much demand they should expect. If the demand for that security is particularly high, they may not have enough shares to sell. In this case, if the contract has a greenshoe option included, they could potentially sell more of that security than was in the original contract. This will allow them to meet the excessive demand for this security. Each contract is going to be different, but in the majority of cases, the underwriter is going to be able to sell at least 15 percent more than what they thought. 

Smooth Out The Market

Whenever there is significant demand for a security without enough supply, this has the tendency to increase the price for that security drastically. When this happens, the market can be very volatile. If the underwriter has the ability to sell more shares than they originally thought, this can help smooth out the market and decrease volatility.