Gray Market Premium: A Complete Guide
Before understanding the meaning of gray market premium, it is vital to understand the meaning of gray market and its working.
Understanding Gray Market
An unofficial market refers to a gray market. Here, the sale of goods is executed outside the official distribution channels. Remember buying a branded watch or digital camera at a price lesser than its MRP? If yes, this purchase was from a gray market. Unauthorised dealers complete the sale of goods in a gray market. It is vital to note that the gray market is unofficial but not illegal.
Now, let us understand what a gray market IPO is?
The colours red and green are common on your trading terminal. They indicate fluctuating prices. But have you ever seen the colour gray on the terminal? It plays a major role in the stock market and relates to the Initial Public Offerings (IPO), particularly Gray Market IPO.
Defining Gray Market IPO
Individuals can buy and sell IPO shares in the gray market IPO before they are listed on the stock exchange. Since the market is unofficial, you do not need to follow any rules and regulations. The settlement of transactions relies on the mutual understanding between buyers and sellers.
There is no regulatory authority. It means that the National Stock Exchange (NSE), the Bombay Stock Exchange (BSE), and the Securities and Exchange Board of India (SEBI) do not have any involvement in the transactions of the gray market.
What is Gray Market Premium?
In the gray market, traders can trade in IPO shares before their stock exchange listing. The transaction is completed at a premium, and it is known as a gray market premium. Investors willingly pay this additional amount over the IPO price to buy the shares.
For example, suppose a company has come up with an IPO. The issue price of the stock is ₹300. The IPO gray market premium is ₹100. Here, investors are ready to pay ₹100 more than the issue price to buy the shares of the company at ₹400 (₹300+₹100). An investor agrees to pay this price because he assumes that the listing price of the stock will be much higher. Thus, he is convinced to pay the IPO GMP.
Conversely, if the gray market premium is (-₹70), it indicates that the investor is ready to sell the shares with a discount of ₹70 (₹300-₹70). The reason for such a decision is the expectation of the shares listing at a lower price.
Implications of Gray Market Premium
- A high GMP IPO means that investors are positive of the share’s performance upon listing.
- A low or negative gray market premium indicates that investors are uncertain about the share’s performance upon listing.
An analysis of the IPO gray market premium can help you ascertain how the stock will perform on a listing day.
You must also understand that GMP IPO is not constant. It is influenced by the demand and supply of shares. Moreover, premium prices are affected to a large extent by the sentiments of the stock market.
Why Do People Trade in Gray Markets?
Using the gray market, investors can purchase the shares of a company even before they are listed. Moreover, if a trader wants to exit the IPO before its listing, the gray market is a solution.
The gray market is unofficial but legal. Investors can obtain data from this market to understand how a stock will perform when it is listed on the stock exchange. Gray market premium is the additional price an investor is ready to pay to buy the shares of a company.
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Frequently Asked Questions
No. It is only unofficial. The term ‘gray market’ is also used to describe the import and sale of goods by unauthorised dealers. This market is also not illegal but unofficial.
There is no regulatory authority for the gray market. Depending on personal preferences, traders can choose their buyers/sellers.
Yes. On selling shares in the stock market, the individual has to pay short-term capital gain on the profit.
The demand and supply numbers determine the IPO gray market price. When the subscription numbers for a particular IPO are more than the mentioned shares, the price of the gray market will be higher. Similarly, if the subscription numbers are less than the specified number of shares, the price will be lower.
There are two types of trading in an IPO gray market:
- Buying and selling IPO applications at a particular premium
- Buying and selling allocated IPO shares before their listing on stock exchanges