A greenshoe option is a provision in an underwriting agreement that gives the underwriter the right to sell investors more shares than originally planned by the issuer -- typically up to 15 percent more shares. This is a useful provision for underwriters in the event of exceptional public demand for a security issue. Legally, it is called an "over-allotment option".
A greenshoe option can provide additional price stability to a security issue, because it gives the underwriter the ability to increase supply and smooth out price fluctuations if demand surges. Some issuers prefer not to include greenshoe options in their underwriting agreements under certain circumstances, such as if the issuer wants to fund a specific project with a fixed amount of cost and does not want more capital than it originally sought.
The term is derived from the fact that the Green Shoe Company was the first to issue this type of option.