Over-Allotted Issues: Greenshoe Option
An underwriter will often sell more shares than will be issued at the public offering. This practice is known as “over-allotment” and it’s a way for the underwriter to have some control over the price of the security in the after-market (after the primary offering has taken place), as well as a way to make additional money.
An over-allotment option, also called a greenshoe option, gives the syndicate the option to require the company to issue up to 15% more shares in the offering at its discretion. If a greenshoe option is granted, the syndicate typically sells additional shares at the offering price by shorting the shares (selling borrowed shares). The syndicate must eventually cover its short position, which it will choose to do in one of two ways.
- 1. Once the shares begin to trade on the secondary market, the price may rise over the public offering price or decline below the offering price. If the stock price declines, the underwriters will cover their short position by buying shares in the market at the lower price and pocketing the difference between the price at which they shorted the stock and the price at which they covered their short position. Buying sh