Investing for Beginners , investing

A greenshoe is an option to sell or buy shares during initial public offering IPO. This option is agreed between the company that goes public and the IPO organizer (some corporate finance firm).

Theoretically greenshoe is prepared to offer more shares (up to 15%) for investors in case of high oversubscription to stabilize the stock price. However, because of flipping popularity more often greenshoe is used to buy stocks on the stock exchange to maintain some increase in the price of stock. 

If the price of shares would drop during first day of trading after IPO it would be a negative psychological sign for future investments in company’s shares. To make IPO successful and bring a confidence for investors some price increase is needed, that is the reason why greenshoe is used. 

In case of high oversubscription greenshoe sells more shares on the market. But if very high oversubscription (over-allotment) happens it means that too low price was determined and IPO wasn’t very successful for the issuing company (it could have raise more capital for higher share price).