Over-allotment options are known as Green shoe options , because in 1919, Green shoe manufacturing Company, was the first to issue this type of option. A green show option can provide additional price stability to a security issue because the underwriter has the ability to increase supply and smooth out price fluctuations.
Green Shoe option is a special provision in an IPO prospectus, which allows underwriters 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. Legally referred to as an over-allotment option.
In short Green-shoe option means an option of allocating shares in excess of the shares included in the public issue and operating a post-listing price stabilizing mechanism for a period not exceeding 30 days. This is an arrangement wherein the issue would be over allotted to the extent of a maximum of 15% of the issue size. From an Investors perspective, an issue with green shoe option provides more probability of getting shares and also that post-listing price may show relatively more stability as compared to market.
There are three types of GSO viz., Full, Partial and Reverse Green shoes. The number of shares the underwriter buys back determines if they will exercise a partial Greenshoe or a full green shoe. A partial Greenshoe is when the underwriters are only able to buy back some shares before the price if the shares increases. A Full Greenshoe occurs when they are unable to buy back any shares before the price goes higher. At this point, the underwriter needs to exercise the full option and buy at the offering price. The option can be exercised any time throughout the first 30 days of IPO trading.
Reverse GSO has the same effect on the price of the shares as the regular GSO, but instead of buying the shares, the underwriter is allowed to sell shares back to the issuer. If the share price falls below the offering price, the underwriter can buy shares in the open market and sell them back to the issuer.