DEFINITION of 'Reverse Greenshoe Option'

A provision contained in an public offering underwriting agreement that gives the underwriter the right to sell the issuer shares at a later date. The reverse greenshoe option is used to support the price of a share in the event that after the IPO the demand for the stock falls.

The underwriter would purchase shares for the depressed price in the market, and sell them to the issuer at a higher price by exercising the option. This activity of buying a large amount of shares in the open market is intended to stabilize the price of the stock.

BREAKING DOWN 'Reverse Greenshoe Option'

A reverse greenshoe option differs from a regular greenshoe option as they are put and call options respectively.

A reverse greenshoe option is essentially a put option written by the issuer or primary shareholder(s) that allows the underwriter to sell a given percentage of shares issued at a higher price should the market price of the stock fall.

In contrast, a regular greenshoe option is essentially a call option written by the issuer or primary shareholder(s) that allows the underwriter to buy a given percentage of shares issued at a lower price to cover a short position taken during the underwriting. Both methods have the same effect of market price stabilization, however it is believed that the reverse greenshoe option is more practical.

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