This paper examines aftermarket trading of underwriters and unaffiliated market makers in the three‐month period after an IPO. We find that the lead underwriter is always the dominant market maker; he takes substantial inventory positions in the aftermarket trading, and co‐managers play a negligible role in aftermarket trading. The lead underwriter engages in stabilization activity for less successful IPOs, and uses the overallotment option to reduce his inventory risk. Compensation to the underwriter arises primarily from fees, but aftermarket trading does generate positive profits, which are positively related to the degree of underpricing.

This paper develops static hedges for several exotic options using standard options. The method relies on a relationship between European puts and calls with different strike prices. The analysis allows for constant volatility or for volatility smiles or frowns.