Greenshoe options - Aramco

[Lumree]

Hey everyone,

So I’ve been keeping an eye on Aramco’s IPO listing and the value has rocketed to £1.9tn. With this, there have come talks of the investment fund utilising a greenshoe option. I want to explain what I think this means and hopefully someone can tell me if it’s right!

Essentially, a greenshoe option is an agreement with an investor to allow for up to 15% of additional shares to be sold to a specific investor. The idea is that this enables the share price to be balanced out against the influx of demand which has caused shares to trade above expected value. The idea, then, is selling additional shares will balance out the demand and stabilise the price.

From a law firms perspective, the work comes from drafting this IPO to include such a clause.

Is this correct?

Thanks!

 

[Andreasyau1]

I would say that the Greenshoe option is an agreement between the issuer and the underwriter rather than between between issuer and investor since it's contained in the underwriting agreement between the issuer and the investment bank underwriter. So it would be immediately relevant for the firm advising the underwriters and are drafting the underwriting agreement. I believe that when articles say that 'Saudi Aramco is exercising it's greenshoe option' it means that the underwriters the ones exercising it (on their behalf and maybe earn a profit if shares trade higher than expected)

And yes from what I've learned greenshoe/over allotment options are used as a price stabilizing mechanism when shares trade above expected value or when a broke issue occurs.

 

[Lumree]

I would say that the Greenshoe option is an agreement between the issuer and the underwriter rather than between between issuer and investor since it's contained in the underwriting agreement between the issuer and the investment bank underwriter. So it would be immediately relevant for the firm advising the underwriters and are drafting the underwriting agreement. I believe that when articles say that 'Saudi Aramco is exercising it's greenshoe option' it means that the underwriters the ones exercising it (on their behalf and maybe earn a profit if shares trade higher than expected)

And yes from what I've learned greenshoe/over allotment options are used as a price stabilizing mechanism when shares trade above expected value or when a broke issue occurs.

Makes sense - thank you!

 

[Syafiqkay92]

I would say that the Greenshoe option is an agreement between the issuer and the underwriter rather than between between issuer and investor since it's contained in the underwriting agreement between the issuer and the investment bank underwriter. So it would be immediately relevant for the firm advising the underwriters and are drafting the underwriting agreement. I believe that when articles say that 'Saudi Aramco is exercising it's greenshoe option' it means that the underwriters the ones exercising it (on their behalf and maybe earn a profit if shares trade higher than expected)

And yes from what I've learned greenshoe/over allotment options are used as a price stabilizing mechanism when shares trade above expected value or when a broke issue occurs.

Thank you for the information but I still don't understand how exercising greenshoe options can stabilise share price. Supposed the price of the share falls after an IPO, isn't selling more of the shares will cause the price to drops further because when supply increases, the price will decrease?

 

[Andreasyau1]

The goal of the underwriters is to sell the shares as close to the offer price as possible and avoid price volatility for the issuing company. Let's say that (x) = size of the share offering.

Underwriters are allowed to sell an additional allocation (y) of the offering size. If they see that investor demand is high, they will sell (x + y) to the market. Because the underwriters do not have y, they are shorting the stock and would need to cover their short positions.

Scenario A: share price trades above the offer price because the demand > supply. Underwriters would want to bring the price down to the offer price. Therefore, they exercise the Greenshoe option, which is to buy 15% more shares at the offer price from the issuing company. By selling this 15%, they can prop up supply in the market and bring the price down and 'stabilize' it.

Scenario B: share price trades below offer price because the demand < supply. Underwriters would NOT exercise the Greenshoe option. Rather, they would buy back (y) from the market to decrease the supply of shares relative to the demand. This would bring the price back up and 'stabilize it'.

 

[Salma]

https://www.google.co.uk/amp/s/amp.ft.com/content/db9cb912-1cf4-11ea-9186-7348c2f183af

Update - Saudi Aramco has now hit the 2 trillion mark and is now the worlds first $2 trillion company.

 

[Ricky]

https://www.investopedia.com/terms/g/greenshoe.asp

 

[Lumree]

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