Greenshoe or Over Allotment Option

In the prospectus for an IPO, the investment bank is sometimes given an over allotment option, also called a greenshoe.  It gives the bank the right to sell 15% more shares beyond the original deal.  The strike price of the right is the offering price.  It's the only legal way to stabilize the aftermarket for an IPO.

Scenario 1:  The deal drops below the offering price.  The bank over allocates the number of shares by 15%.  In essence, it has a short position where the shares are sold at the offering price.  When the share price goes down, the bank buys it back at or below the offering price until its short position has been closed.

Scenario 2:  If the IPO trades higher than the offering price, the bank still over allocates the shares by 15%.  If it is unable to buy back any shares at the offering price, it avoids a loss by exercising the full greenshoe.  In the case where it is able to buy some shares, it will exercise a partial greenshoe.