What is Grey Market in IPO? GMP, Benefits, and How Does it Work in Trading?

The IPO process is usually accompanied by a lot of noise, speculation, and excitement. Of several factors that an investor considers before subscribing to an IPO, one word that pops up frequently is Grey Market Premium (GMP). But what is the grey market? The grey market refers to a private and unofficial marketplace wherein securities are exchanged before being formally listed on a stock exchange.

The grey market affects investments in IPOs by giving an indication of market perception and requirements for IPO shares. Let's examine more closely the definition, classifications, and operations of the grey market while simultaneously considering its impact on investor sentiment.

What is the Grey Market?

The grey market is, also a parallel market; it refers to the selling of goods or services through unverified channels instead of through the established legal distribution. It encompasses all transactions that occur outside the official distribution channels set up by the producer.

In the grey market for IPOs, investors can trade shares of companies that are going to go public but are not yet listed on the stock exchange. This enables investors to speculate on the likely movements in the prices of shares before those shares are available for trading in the open market, which is called IPO in the grey market.

Understanding Grey Market in India

Demand and supply determine the functioning of grey markets; traders and retail investors buy shares ahead of the official listing. Grey market provides an option to back out of the IPO for any reason. Even after the deadline for IPO applications, people can acquire shares through this unofficial channel.

Before an IPO, a company can trade its products and shares in the grey market. Such markets give underwriters and investors a sneak peek at possible listing behavior, thereby allowing them to estimate the IPO premium in grey market.

What is Grey Market Premium(GMP)?

The premium or discount at which IPO shares are traded in the grey market before official listing is termed IPO GMP. The premium reflects the perception of investors regarding the demand for a particular IPO. A high grey market premium for an IPO denotes strong interest, whereas a lower GMP may indicate feeble sentiment among investors.

Factors affecting GMP include:

1. Market spirit :

When the stock market is bullish or highly active, investor enthusiasm increases. This upbeat sentiment drives traders to take early positions in promising IPOs through the grey market. As a result, the Grey Market Premium (GMP) rises quickly in fast-moving markets. In such conditions, investors expect strong listing gains, which further fuels demand in the unofficial grey market.

2. Company fundamentals :

Strong company fundamentals such as consistent revenue growth, solid profit margins, a good business model, and an experienced management team create positive investor sentiment. These qualities signal long-term potential and financial stability, which makes the IPO attractive. When the fundamentals are strong, grey market investors are willing to pay a higher premium even before the stock is officially listed.

3. Supply and Demand :

Grey Market Premium is essentially a reflection of how much investors are willing to pay above the IPO price. When demand for the IPO is high due to positive buzz, limited allotment, or expected listing gains the GMP tends to increase. This demand-supply gap in the grey market, where more buyers are chasing fewer shares, pushes the premium upward.

4. Industry trends :

If the company operates in a booming or futuristic sector (like AI, green energy, or fintech), it benefits from the overall positive sentiment of the industry. Investors are more likely to trust and invest in companies from trending sectors, even at a premium. On the other hand, if the industry is facing regulatory or financial stress, the GMP may remain low regardless of the individual company's strengths.

Example to Understand GMP:

Let's take an example to clarify this:

Issue Price: ₹ 500

The problem price is the fixed price or price band fixed by the company during the IPO. This is the amount that investors pay to apply for an IPO.

GMP: ₹ 100

GMP in the stock market refers to grey market premium (GMP), which indicates the additional price that investors are ready to pay for a share prior to its listing. A high IPO gray market premium reflects strong demand and positive sentiment in the market.

Expected Listing Price: ₹ 600

GMP (100) provides the requisite listing value to be added to the issue price (500). Though this is not absolute, it gives investors an idea of the price range they could foresee on the listing day of the share.

Types of Trading in the Grey Market

1. Trading IPO Shares :

Before their official listing, investors buy or sell the IPO shares they have been assigned.

2. Trading IPO applications :

Depending on the expected demand, investors trade IPO applications at a specific premium or discount.

How are IPO shares done in the grey market?

The process of trading IPO shares in the grey market includes several stages:

1. IPO application :

In the case of an IPO, investors apply for shares.

2. Buyer Interest :

Buyers want to acquire shares before the listing from grey market dealers.

3. Conversation :

Dealers match buyers with sellers for a pre-agreed premium.

4. Transaction execution :

In case a seller has been allocated, the shares get transferred to the buyer's demat account at a previously defined price.

5. Risk of Non-Activation :

If no share vendor is allocated, the transaction is canceled.

What are the Benefits of the Grey Market?

The following are some Benefits of the internet grey market:

1. Availability of rare or limited version products :

This market provides access to unique and hard-to-fit products that may not be easily available through authorized channels.

2. Better Pricing :

The gray market of IPO often offers more competitive or discounted pricing than formal channels.

3. Potential for high profits :

For vendors working in the grey market, there is a chance to earn high profits by sourcing products at low cost and selling them at a markup.

Advantages of Trading in the Grey Market

1. Early Access :

Before shares are formally listed on the stock exchange, investors can purchase them, potentially obtaining a better price.

2. Liquidity opportunity :

Investors have the option to sell their initial public offerings (IPO) shares prior to the official listing, enabling them to exit early and either book profits or cut losses.

3. Price Search :

Helps investors to estimate the market demand for a stock and predict its potential listing value before it is publicly traditional.

Risks of Trading in the Grey Market

1. Lack of regulation :

Grey market trades are dangerous because they take place outside of the official stock exchange and are not subject to any regulations.

2. High Risk :

Share prices in the grey market can unpredictably upset and rise, causing possible damage to the stock before it is officially listed.

3. No legal support :

Since grey market transactions are informal, investors cannot seek legal aid or regulatory intervention if they face damage or disputes.

Conclusion

The grey market plays an important role in the pre-listing phase of the IPO, giving investors a taste of market sentiment before official trading begins. While it offers early access and potential profit opportunities, it carries significant risks related to regulation and a lack of transparency.

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