The ideal market response post IPO is one of stability and order, a consistent and gradual appreciation in share price is often the hallmark of a successful IPO. This desired state is precisely where the overallotment option, also known as the green shoe option, play a pivotal role. Let's examine the intricacies of this option through a practical example. Suppose a company has set its IPO price at $5 per share with an announced issue of 60 million shares. The underwriters in anticipation of potential market fluctuations may allocate an additional 9 million shares, an over allotment of 15% to be precise.

In the event of enthusiastic market reception where the share price climbs to $6, the green shoe option comes into play, not by supplying additional shares to the market, but by giving underwriters the ability to avoid buying back the over allotted shares to cover their short positions. By exercising the green shoe option, they can instead obtain the over allotted shares directly from the company at the original IPO price of $5. Thus avoiding putting extra upward pressure on the market price. For the issuing company this means that it has issued a total of 69 million shares at $5.

On the contrary, if the share price decreases to $4, the underwriters refrain from exercising the green shoe option. Instead, they support the share price by buying back the 9 million shares from the market. A move that not only aids in price stabilization, but also enables underwriters to benefit from the difference between the higher IPO price and the lower market purchase price. The green shoe option is a testament to the sophisticated strategies designed to maintain orderly market conditions. It ensures that the underwriters can effectively fulfill their role as market stabilizers without contributing to the kind of volatility that could undermine the newly public company's market entry.