Reverse Greenshoe Option

Posted in Finance, Accounting and Economics Terms, Total Reads: 89
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Definition: Reverse Greenshoe Option

Reverse Greenshoe option is an option provided to the underwriter of a security in cases of an IPO, which allows the underwriter to sell the security back to the issuer.

Reverse greenshoe option is essentially a put option which allows the underwriter to sell the security back to the issuer at the original price when the price of the security falls. Since the underwriter first buys the stock at the open market in a good quantity, the price of the stock comes back to normal. The main purpose of exercising this option is to prevent the losses from the dropping price of the stock. The bulk buying the shares from the open market allows the price of the share to rise up. Suppose a stock IPO was issued at $10, following table will explain when the underwriter executes the reverse greenshoe option:


Market Price

Action

Profit/Loss

$10

No action by the underwriter

NA

$12

No action by the underwriter

NA

$14

No action by the underwriter

NA

$11

No action by the underwriter

NA

$8

Underwriter buys a certain number of shares at $8 and sells them to issuer at $10 through exercising the option

$2 Profit made by buying at $8 and selling at $10


A regular greenshoe option works differently from the reverse greenshoe option since it is a call option. If allows the underwriter to buy the shares from the issuer. In that if the price of the stock rises, the underwriter executes the option and buys the shares from the issuer at the original price which is lower than the market price.

For Example: Suppose there is a new IPO in the market. The underwriter of that IPO security sells 100% of the issued stock. Suppose the IPO was issued at $20. Now after the IPO if the price of the stock falls to $15. The underwriter will buy certain number of shares from the open market at $15 and will execute the option and sell the stock back to the issuer. This way through bulk buying from the market the price of the stock again rises and settles higher than $15.

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