If you are a stock market and IPO enthusiast you must have come across the term Grey market or GMP (Grey Market Premium). But many of us do not know the exact meaning and relevance of GMP in the IPOs.

Here, we are going to particularly talk about the grey market premium, its relevance and significant aspect to gain a better understanding.

What is the Grey market?

Grey market is a platform or market where investors buy and sell IPO shares of companies even before they are listed and launched in the market officially. All the transactions taking place here are in person and in cash. There is no third party like regulators, exchanges, bankers are involved, this is why trust is a very significant component in the grey market. All trade places in this market are based on mutual trusts between the buys and sellers. As this is an unorganized and unregulated market, there is a very small bunch of people participating in the same and there are no guidelines, rules and regulations that define the market.

Grey market can be classified into 2 parts on the basis of trading:

Trading of IPO application before allocation at a discounted or premium rate.
Trading allocated IPO shares after the allocation but before the listing on stock exchange at a discount or premium rate.

What is Grey Market Premium?

Grey Market Premium is a term used to estimate the price at which the IPO application shares will be listed in the market officially. This grey market operated before the official listing and it starts from the very first day of IPO start date. With this, Investors can get to know the reaction on listing with an estimated price for the issue and application. They can check GMP of various IPOs on different websites like IPO watch among others. The GMP varies on a day to day basis based on the demand of the issue. If the securities have a good demand before listing, they might open on profits at higher end. The IPO securities which have less and weak demand among the investors of the grey market might open at a negative price band.

Lets understand with an example:

A share with IPO price of Rs. 250 is trading at a GMP of Rs 100. It indicates that there is a possibility of the stock getting listed at around Rs 350 which is the price plus GMP.

Why Grey Market Trading?

People trade in the grey market because it provides an opportunity for traders and retail investors to purchase the shares even before the listing if they feel the stock is going to increase in its value. It permits people to trade IPO shares even after the last day or deadline. It also assists the business which is going public as they get an idea about the demand of their shares in the grey market. Many shares are also being listed here which are not able to get listed officially on BSE and NSE.

Understanding Selling IPO Application in Grey Market

Identical to IPO shares trading, even IPO applications also include buyers and sellers.

Depending on market conditions and multiple assumptions, buyers determine the application price. The buyer makes an offer to the sellers in the market that they are willing to buy an application at a specific premium.

Sellers may sell their application at a specific premium to the buyer through a dealer present in the grey market to avoid financial risk.

In this scenario, there is no need to worry for the seller about the share allotment in the IPO, Even if the seller does not get any allotment they still get the grey market premium at which they sold the application.

The seller sends the details of application to the dealer. Then the dealer notifies the buyer that they bought an application at a specific premium from the grey market seller.

If the seller gets the allotment, the seller may get a communication from the dealer to transfer allocated shares to some demat or sell them at a specific price.

This settlement is done based on loss or profit, in case of selling the securities.

If there are no securities allocated, the deal is cancelled without any settlement being made. But the seller will still get his premium as they sold their application.

Price Regulation in Grey Market

Various factors like the interest of retail traders, how much oversubscribed the IPO is, institutional traders, who the promoters are and who are the underwrites, etc drive the piercing of IPOs in the grey market as there are no specific compliances and rules for it.

If the rate of IPO shares or IPO application is trading at a lower or discounted price than the bid price in the grey market, then it is said that the IPO is being traded at a grey market discount.

If the rate of IPO shares or IPO application is trading at a price higher than the bid price in the grey market, then it is said that the IPO is being traded at a grey market premium.

Conclusion

To summarise, we can say that GMP reflects the market sentiment about the IPO before its listing. Nevertheless, GMP does not indicate a sure shot price at which the IPO will be listed because there are multiple factors other than it that influence the IPO listing price among which one of the major factors is the market scenario and condition on the date of listing.