A Greenshoe option, also known as an overallotment option, is a provision that allows underwriters to sell additional shares in an initial public offering (IPO) or a secondary offering of securities. This option provides flexibility to stabilize the price of the newly issued securities and meet market demand. The Greenshoe option is typically granted by the issuing company to the underwriters.

Key points about the Greenshoe option:

1. **Stabilizing Mechanism:** The Greenshoe option acts as a stabilizing mechanism in the aftermarket of an IPO. If the demand for the newly issued securities is strong and the market price rises above the offering price, the underwriters can exercise the Greenshoe option to sell additional shares at the offering price.

2. **Over-Allotment Option:** The Greenshoe option allows underwriters to allocate more shares than originally agreed upon in the underwriting agreement. This option is exercised at the discretion of the underwriters and is typically limited to a specific percentage of the original offering size.

3. **How It Works:** Suppose a company decides to go public and issues 10 million shares in the IPO. The underwriters may be granted a Greenshoe option for an additional 15% of the offering size, allowing them to sell an additional 1.5 million shares. If there is strong demand for the stock, the underwriters can purchase these additional shares from the issuer at the offering price.

4. **Price Stabilization:** The Greenshoe option helps stabilize the stock price in the secondary market. If the stock price rises significantly after the IPO, the underwriters can cover their short position by purchasing shares at the offering price and returning them to the issuer. This helps prevent excessive price volatility.

5. **Underwriters’ Profit:** Underwriters make a profit by selling the additional shares at the market price, which is often higher than the offering price. The difference between the offering price and the market price represents the underwriters’ profit.

6. **Overallotment Agreement:** The overallotment option is specified in the overallotment agreement between the issuer and the underwriters. The agreement outlines the terms and conditions under which the Greenshoe option can be exercised.

7. **Time Limit:** The Greenshoe option typically has a time limit during which it can be exercised, usually within 30 days of the IPO. After this period, the option expires, and the underwriters cannot purchase additional shares from the issuer.

The Greenshoe option benefits both the issuer and the underwriters. It provides price stability for the stock in the early days of trading and allows the underwriters to manage their inventory and respond to market demand effectively.