Understanding the Gray Market
A gray market refers to an unofficial marketplace where financial securities are traded. This type of trading typically occurs when stocks are suspended from official trading or when new securities are exchanged before their official market debut. The gray market helps issuers and underwriters assess the demand for new offerings, as it operates on a “when issued” basis, meaning it deals with securities that are set to be released soon. While the gray market is unofficial, it is not considered illegal.
The term “gray market” also applies to the unauthorized import and sale of goods by dealers. In this context, the activity remains unofficial but is not against the law.
How the Gray Market Operates
The gray market, also known as a parallel market, is an informal platform for trading stocks and applications. Investors in this market trade shares or applications before they are officially listed on stock exchanges. In India, for instance, gray market stock transactions are conducted in cash and in person, without the involvement of third-party entities like stock exchanges or regulatory bodies such as SEBI. Key terms in the IPO gray market include Kostak and Grey Market Premium (GMP).
Grey Market Premium (GMP) in IPOs
The Grey Market Premium (GMP) represents the extra amount at which IPO shares are traded in the unofficial market before their official listing. Essentially, it is where IPO shares are bought and sold outside the formal stock market. GMP provides a glimpse into how an IPO might perform upon listing. For example, if an IPO is priced at Rs. 1000 and the GMP is Rs. 20, the expected listing price would be around Rs. 1020. Although not always precise, GMP often serves as a reliable indicator of the IPO’s potential listing price.
Types of Gray Market Trading
Gray market trading can be divided into two main categories:
- Pre-Listing Trading: Buying or selling IPO shares before they are officially available on stock exchanges.
- Application Trading: Trading IPO applications at specific rates or premiums.
Since these transactions are passively managed, there is no risk of a fund manager making incorrect decisions.
Calculating the Grey Market Premium (GMP) of an IPO
Understanding GMP can help you decide whether to invest in an IPO. GMP is a key indicator of the demand and potential price of an IPO before it is officially listed. To calculate GMP, you compare the IPO’s issue price in the primary market with its trading price in the gray market.
Formula for GMP:
GMPR = Gray Market Premium × Number of Shares
Step-by-Step Guide to Calculate GMP:
- Gather Information: Collect the latest data on the IPO’s gray market price and its issue price.
- Determine GMP: Subtract the IPO’s issue price from its gray market price. For instance, if the issue price is ₹100 and the gray market price is ₹102, the GMP is ₹2 per share.
- Calculate GMP Percentage: Divide the GMP by the issue price and multiply by 100 to get the GMP percentage. Using the example above: (2 / 100) × 100 = 2%
Example Calculation:
- Issue Price: ₹100 per share
- Gray Market Price: ₹102 per share
- GMP: ₹102 – ₹100 = ₹2 per share
- GMP Percentage: (2 / 100) × 100 = 2%
