What is Grey Market?
Formally and legally, share trade on the primary and secondary markets. Securities Exchange Board of India (SEBI) regulates primary and secondary markets. New shares are issued and sold to the general public in the primary market. An example of a primary market is the Initial Public Offering. Following their listing, shares trade on the secondary market. SEBI facilitates and regulates the transactions that occur on the primary and secondary markets through stock exchanges. The GMP in IPO for stocks is a closed and informal market that functions on the basis of trust rather than rules.
Prior to their listing, shares trade informally on the grey market. Furthermore, it is not regulated by SEBI or any other regulatory entity. Thus, investors must assume all risks associated with transacting on the grey market. Grey market transactions are conducted via small slips of paper and unofficial/ unregistered dealers. The significant demand for grey market trades makes them relevant even though the market is not regulated.
Recommended Read: IPO Process in India
How Does a Grey Market Work?
There are two ways to transact on the grey market. The first method is to purchase or sell IPO shares on the grey market before they are publicly available for trading. The second method is by selling the IPO application for a certain price.
IPO Shares Trading on the Grey Market
Following are the steps to deal in shares trading on the grey market:
- Through an IPO, investors apply for shares. They assume a financial risk since they may not receive any shares or may receive shares that trade below the issue price. These individuals are known as sellers.
- Few persons believe that the share’s value exceeds its issue price. Thus, they begin accumulating these shares prior to their allocation via the IPO allotment procedure. These individuals are known as buyers.
- Through the grey market dealers, buyers place orders to purchase IPO shares. For purchasing them in the grey market, buyers offer a specific premium.
- Next, the dealer contacts the sellers who submitted applications for the IPO and inquires whether they are willing to sell their IPO shares for a certain premium at the moment.
- Meanwhile, if the sellers are unwilling to assume the risk of a stock market listing and like the premium offered by the grey market dealer, they may sell the IPO shares to the dealer and pocket the profit. However, the seller must complete the transaction at a specific price with the grey market dealer.
- The dealer receives the application information from the seller and notifies the buyer about the share purchase.
- During the allotment, the sellers may or may not receive shares.
- If the seller gets the allotment, the dealer will contact the seller and ask them to sell the share at a particular price. Alternatively, the seller can transfer allocated shares to a Demat account as well.
- If an investor is selling shares, the settlement is determined by the investor’s profit or loss and the grey market premium at which buyers and sellers transact.
- If the seller doesn’t get any allotment, there will be no settlement.
IPO Applications Trading on the Grey Market
IPO applications also include both sellers and buyers. Following are the steps to deal in IPO applications trading on the grey market:
- The price of an application is determined by buyers based on several assumptions and market conditions. They offer the seller to purchase an IPO Application at a certain premium.
- To safeguard their investments, sellers may sell their application to the buyer at a premium through a grey market dealer.
- In an IPO, the seller does not need to worry about the allocation of shares. Even though they don’t receive any allotment, they still receive the grey market premium. Since the seller already sold the IPO application.
- The seller sends the dealer the application form. Next, the dealer notifies the buyer that he purchased an IPO application from sellers on the grey market for a specified premium.
- The seller may or may not receive a share allocation.
- Suppose the seller gets the IPO allocation. In that case, either seller may receive a phone call from the dealer instructing them to transfer allocated shares to a Demat account or sell them at a specified price.
- If shares are sold, the settlement is determined by the profit or loss.
- If the seller gets no allotment, then the transaction becomes void. However, the seller still receives the premium for the application he sold.
Grey Market Premium (GMP) refers to the premium amount at which IPO shares trade on the grey market prior to their listing on the stock exchange. In other words, you can buy and sell the shares of the company outside the stock exchange.
The GPM reflects how the IPO may react on the day of its offering. For example, if the firm introduces an IPO for INR 500 and the grey market premium is approximately INR 100, it may anticipate that the IPO would list for approximately INR 600 on the day of listing. Though GMP prices are unreliable, in most instances, the GMP reflects the IPO listing price.
What is the Importance of GMP?
Following is the importance of GMP:
- According to retail investors, GMP is a good indicator of whether an IPO is doing well or not.
- GMP may also indicate the degree of interest among the investors in an IPO.
- Though the GMP prices are unreliable, they are a good indicator of the possible listing price of the share. Thus, it is an excellent parameter to consider before investing in an IPO.