We often hear in the news that some or other company is planning its IPO. As most of us know, when a company brings in an IPO, it wants to raise capital from the public by selling its shares and getting the stock listed on the stock exchange. But a question might pop into your mind “who holds these shares before the company goes for an IPO?”
Before these stocks get listed, promoters of the company, its employees, investors, investment banks, etc., hold these shares. These key persons can buy or sell these stocks between themselves or to other interested parties even before the stocks get listed on the exchanges.
Now, this brings us to the main topic of our blog.
What is grey market?
The term “grey market” refers to a market where shares trade before their initial public offering (IPO). In this market, transactions occur between individuals, investors, and institutions outside official channels, hence the name “grey market.” Although buying and selling shares in this manner is not illegal, it is considered a grey area between legal and illegal trades due to its unofficial nature.
What is Grey Market Premium in IPO?
When a company announces an IPO, the trading activity of its stocks in the grey market increases, and the participants in the grey market try to get the stock even before the stocks get listed. As the prices at which these transactions are taking place may be higher than or lower than the price at which the IPO will come, a premium gets charged over the IPO price band. This difference between the IPO price band and grey market prices is called a Grey Market Premium in IPO.
For eg: If the IPO price band for company X is โน90-95 and in the grey market it is being traded at โน130 then, the grey market premium for the company is โน130 – โน95 = โน35.
How Grey Market Works?
Just like traditional brokers facilitate users with the facility to trade on the exchanges, there are grey market dealers who facilitate transactions in the grey market. These grey market dealers earn money in two ways.
Transactions for previously owned shares
In this route, the shares that the company’s employees, investors, and institutions own are sold to the parties interested in buying them at a grey market premium price by the dealer.
Transactions of successful IPO applications
In this route, after the IPO allotment is done, grey market dealers facilitate the exchange of successful applications for money between interested parties before the stock gets listed on the exchange. The higher the chances of getting listing gains on the day of listing on the exchange, the higher the grey market premium will be, and vice versa.
Suppose you applied for shares of XYZ
company’s IPO and received an allocation of one
lot at โน100 per share. Now, a dealer in the grey market
offers you โน120 per share to sell your rights to buy
those shares. If you accept the offer, you would make a
profit of โน20 per share.
Later, the dealer sells those shares to another customer for โน125 per share, making a profit of โน5 per share. If, on the day the shares are officially listed for trading, their price doesn’t go higher than โน125 per share, the final customer who bought the shares will be at a loss.
How to invest in grey market?
There are many websites these days that can help in buying or selling stocks through the grey markets. Apart from them, you can contact traditional grey market dealers directly to invest money in grey market shares.
How can Grey Market Premium be used as an indicator?
Grey market premium tells the investors who want to apply for an IPO about how much listing gains they can expect from the stock. If the grey market price is higher than the price band decided for the IPO, then the stock will probably list at a price closer to the grey market price and vice versa.
This grey market premium data can help a retail investors to decide whether they should apply for the IPO or not.
Final Thoughts
Participating in the grey market can be a tricky affair, and there have been many cases where fake dealers duped investors of their hard-earned money. Hence, without verifying the party on the other end, one should not directly participate in the grey market and always use official channels to participate in equity markets.
An individual retail investor may use grey market premium as an indicator to decide whether to apply for an IPO or not, but there is no guarantee of its accuracy.
At WealthDesk, we help you to invest in WealthBaskets, i.e. the combinations of stocks and ETFs reflecting an idea, theme, or investment strategy, and are created by SEBI-licensed investment advisors and research analysts.
FAQs
No, the grey market is a separate, unofficial market and does not form part of the IPO.
Through the grey market premium price, one may get a fair idea about the stock’s listing price. However, there is no guarantee that the listing price will be equivalent to the grey market price.
Since grey market price indicates the prices at which transactions are currently taking place and hence the expected listing gains, investors can choose whether to subscribe for an IPO or not. If the grey market premium is high, more investors will be interested in buying the stock to get listing gains. Hence, the IPO issue may get oversubscribed, while in the case of a lower grey market premium, investors may not subscribe to the IPO.
Grey market prices reflect the mood of primary markets during the IPO process and can be used as an indicator. Hence, some investors consider the grey market price, but they are not directly related to IPO listing.
Many factors influence the price of an IPO in the
grey market, like the demand for shares, the
company’s fundamentals, the future potential
of the company, the promoter’s pedigree,
etc.
Apart from this, how individual investors
participate in the IPO process and how many times
the IPO gets oversubscribed also affects the grey
market price of a stock.
