The stock market is a world of both simple and complex systems, where investors profit based on knowledge. As a beginner, catching up with this knowledge is important, and one of these is the IPO Grey Market Premium.
So, what is the Grey Market Premium, and what does the Grey Market mean? How does the whole system work? These are the questions to which answers are provided in this article.
At the end of the article, you will be fully equipped with most of the knowledge you need to understand IPO Grey Market premium.
What is IPO Grey Market Premium (GMP)?
The Grey Market Premium (GMP) is the difference between the Initial Public Offering (IPO) issue price and the price investors are willing to pay for the same shares before official listing.
Formula:
Grey Market Premium = Grey Market Price – IPO Issue Price
Where:
- IPO Issue Price = The official price set by the company for its shares
- Grey Market Price = The unofficial pre-listing trading price
If the GMP is positive, it means investors expect the shares to list higher; if negative or zero, market enthusiasm is weak.
Simple Explanation of Grey Market IPO Premium
Imagine you own a company that makes shoes. You intend to release a limited edition of a new line of designs. However, you allow your merchants to propose how much they intend to pay for a pair of shoes, based on how much retailers and buyers think the shoes will be worth.
However, it is expected that the amount these players are willing to buy and sell your new line for ought to be more than the amount you would eventually sell them for when you launch them.
The above illustration explains what Grey Market IPO premium means.
The Grey Market IPO premium is simply the extra amount buyers and sellers are willing to pay for the shares of a company in the Grey Market before it officially goes public with its IPO.
So, Company A decides to sell its shares in an IPO at ₹100 each. But, before the shares appear on the official stock exchange, buyers in the grey market agree to pay ₹120 to get its shares early. That means the GMP is ₹20.
How the Grey Market of IPO Works
To fully grasp this system, an understanding of how the stock market works matters.
When a company wants to get listed in the stock market, it offers what is called an IPO, which stands for Initial Public Offering. An initial public offering is the process through which a company sells a portion of its equity to the public in the form of shares for the first time.
Note that every country has its capital market, a complex system of hundreds and thousands of companies selling shares. It is a system that brings together these companies with potential buyers. The Indian capital market operates under two main exchanges, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), and both are regulated by the Securities and Exchange Board of India (SEBI)
The SEBI and its several departments perform several critical duties, including oversight, regulatory control, and investor protection, to ensure transparency in market operations.
So how does the Grey Market IPO work?
Before the official date of an IPO, a company’s shares can be traded unofficially in what is known as the Grey Market. This is neither “black” (illegal) nor “white” (official); hence the name “grey.”
To understand this, consider the illustration below:
You have a company that sells waterproof materials. You announce you are about to release a new product. However, on a stated date, the cost of the product isn’t shared and won’t be until the day of release. Still, you leave the door open for people to pre-order based on how much they think the product would cost.
This succinctly explains the Grey Market.
The Grey Market is very different in operation and expectation than the Stock market.
- Over Priced
As stated before, the very nature of the Grey Market IPO is that investors price it speculatively more than the prospective price of the actual IPO. It is from this concept that the term “Grey Market” is coined.
- Speculative Nature:
The Grey Market is highly speculative. What this means is that the price at which people buy and sell shares of a company before its IPO is largely determined by market sentiment.
- Non-binding Intent:
The intention to buy several shares in the Grey Market is not legally binding. Effectively, what this means is that an interest in buying a unit of a share for a certain amount isn’t a legal obligation to purchase at their desired price once the IPO opens.
- Unreliable Price Data:
Because prices of shares in the Grey Market are speculative, and rarely reflect the true valuation of a company’s shares, they are not a dependable data upon which one can judge a company’s actual IPO pricing.
Why Investors Track Grey Market IPO Price
Despite being unregulated, speculative, prone to manipulation, and largely unreliable, the Grey Market has certain advantages.. Below are a few reasons why investors track the Grey Market IPO Price.
- Measurement of Demand:There are several sources of information that investors can use to measure the demand for a company’s shares when they are going public, including the company’s prospectus published in NSE India. However, the Grey Market provides additional “street-level” sentiment.
- Forecasting IPO Price:Investors sometimes use Grey Market prices to forecast potential listing gains or losses. While this information is not always accurate, it can provide an idea on how much investors can expect to pay.
- Decision-Making:Knowing the speculative demand helps investors decide whether to apply for an IPO and how much capital to allocate.
- Early Exit Strategy:On the possibility that an investor would be awarded the number of shares he demands at the Grey Market, it gives him leverage to sell quickly post-listing if they foresees price declines, leveraging the informal knowledge gained from Grey Market trends.
Risks of Depending on Grey Market IPO
- Unregulated System:The Grey Market is not governed by SEBI. Therefore, players do not have any form of legal protection in the course of disputes.
- Price Manipulation:Due to its speculative nature, the Grey Market is prone to manipulation by bad operators who might artificially inflate or suppress GMPs to influence investor behavior in the actual IPO.
- Settlement Risk:There is no guarantee of transaction completion. Sellers may default, or buyers may back out, as agreements are informal.
- Liquidity Risk: Limited participation leads to lower liquidity, meaning investors might get stuck with unsold shares if demand finally fails to meet expectations.
Conclusion
The IPO Grey Market Premium is an interesting concept that is as advantageous as it is risky. Smart investors are always on the lookout for any information that would give them an edge when it comes to winning in the Capital Market, and the Grey Market is one of those tools that provides a level of leverage.
