Reverse Greenshoe Option

A reverse greenshoe option helps manage post-IPO stock price fluctuations by allowing underwriters to buy back shares if the price falls below the offering price. Unlike the traditional greenshoe option, which involves selling additional shares, the reverse option prevents sharp declines and reassures investors.

A greenshoe option allows underwriters to sell up to 15% more shares during an oversubscribed IPO, stabilising the stock price by absorbing excess demand.

How the Greenshoe Option Works

If the stock price rises, underwriters sell more shares to stabilise it. If it falls, they buy back shares to support the price.

The reverse greenshoe option works similarly but in reverse: if the stock price falls below the offering price after IPO listing, underwriters buy back shares to stabilise the price.

How It Works

In the event of post-IPO volatility, the reverse greenshoe option allows underwriters to purchase shares from the market at the prevailing lower price. This reduces the supply of shares, helping to bring the price back towards the offering price. It provides a safety net for both the company issuing the IPO and the investors, helping maintain investor confidence during the early days of trading.

Difference Between Greenshoe and Reverse Greenshoe Options

The key difference between a greenshoe option and a reverse greenshoe option lies in the direction of trade. In a greenshoe, underwriters sell additional shares to stabilise the price, while in a reverse greenshoe, they buy back shares from the market to prevent the price from falling too much.

The reverse greenshoe option is typically used when the stock price starts to fall below the offering price, and market conditions indicate that the decline might continue. It’s triggered when there’s significant downward pressure on the stock’s price post-IPO, and the underwriters decide to intervene to support the price.

Post-IPO Volatility

Volatility in the stock market, especially after an IPO, is common. The reverse greenshoe option is designed to mitigate this volatility by allowing underwriters to take action to stabilise the stock price.

A reverse greenshoe option offers several advantages, both to the company conducting the IPO and to the investors:

Stabilising Stock Prices

By allowing the underwriters to buy back shares, a reverse greenshoe option helps stabilise the stock price and reduces excessive price fluctuations post-IPO.

Boosting Investor Confidence

When the stock price starts to dip, the intervention through a reverse greenshoe option signals to investors that there is a safety net in place. This reassurance can help prevent panic selling and maintain investor confidence in the IPO.

Protection for Issuers

The reverse greenshoe option provides protection to the company issuing the IPO. If the stock price falls below the offering price, the company could risk significant damage to its reputation. By stabilising the price, the reverse greenshoe option helps maintain the perceived value of the company.

Example 1: XYZ IPO

In a recent IPO of XYZ Corp., the stock price began to dip below the offering price shortly after trading commenced. The underwriters exercised the reverse greenshoe option and bought back shares, helping to stabilise the price and limit further decline. This intervention reassured investors, and the stock was able to recover its value over the following weeks.

Example 2: ABC Inc. IPO

ABC Inc. faced similar challenges when its stock price fell by 5% within the first two days of trading. The underwriters used the reverse greenshoe option to buy back shares from the market, preventing a further drop in stock price. This move helped maintain market stability and investor confidence.

A reverse greenshoe option plays a vital role in the IPO process, particularly in managing post-IPO price volatility. By allowing underwriters to buy back shares and stabilise the price, it protects both the issuing company and investors from excessive fluctuations. While the reverse greenshoe option is not as commonly used as the regular greenshoe, it provides a crucial tool for managing market risk in uncertain times.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.