Grey market premium: Definition and meaning of GMP in an IPO

When it comes to investing in initial public offerings (IPO), most traders look at the grey market premium or the GMP of the stock in question. But what is GMP in an IPO? And why does it matter so much suddenly right before a stock is about to be listed? Continue reading to find out. 

What is the Grey Market?

A grey market is an unofficial stock market that generally supports under-the-table trading of stocks not officially listed on the stock exchanges. This category includes two types of stocks – one, is the stock that has not been launched in the market yet; two, stocks whose trading has been suspended by the market regulator. 

Since it is not backed by the market regulator SEBI, you trade in this market at your own risk. Regardless, many investors trade in the market, with many companies bringing out their public issues in the grey market first. This enables the companies and their underwriters to gauge the demand for their shares. 

How Grey Market works

The grey market works slightly differently than the stock market since it does not have any authority, so to speak. For starters, no one records the number of shares being traded and at what price. Plus, in this type of market (in most cases), while your trades are binding, you can’t settle them until the official trading begins. Due to this, many investors back out from their trades, leading to high losses. This issue is prevented in the official market since SEBI ensures trade settlement. 

The Grey market is highly popular when it comes to IPOs. One of the reasons it was established in the first place was that most promoters of Indian companies found it hard to raise money from the public via IPOs. This was back when the multinationals were yet to go public. So, the company promoters and merchant bankers created a parallel market to build an impression that their share offerings are worth more than what is being offered in the public issue. The investment bankers would price the stock at a lower value than its IPO price. And then, they would have some brokers buy the shares at a small premium, which created the impression that investment bankers were going for. In the process, if the investment bankers lost money, they would be reimbursed by the promoters of the company. 

And at the time, since most of the issues would just about be subscribed, the traders did not mind the move too much. This means if one invested in the public issue, they would almost certainly get the full quantity of shares they applied for. Since the trade could not be settled until the official public issue, traders would sell the shares at a premium in the grey market. They would then buy an equivalent quantity of shares at a lower price in the IPO. This way, they could pocket the profit generated by the difference in the grey market price and the IPO price. 

These days, the grey prices are a fair indicator of the demand for a company’s stock slated for an IPO. This is true for renowned companies. For smaller companies, however, the investment banker to the issue strikes deals at prices to give the impression that the demand is high, as explained earlier. 

What is the Grey Market Premium or GMP in an IPO?

Grey market premium or GMP is the difference between the offered price of a stock and the price at which it is trading in the grey market. For example, company A fixes its IPO price at Rs 100 and its grey market price is Rs 150. Then the GMP is Rs 50. 

Generally, the stocks are expected to list at around the same levels as the grey market price. So, in A’s case, the listing price would be approximately Rs 150. However, this is not always true.

What are the parameters for GMP?

The GMP is more significant right around the time of the stock’s official listing on the bourses. It is at this time that the demand for the stock is high. The GMP usually rises on the back of the company’s popularity, exciting business model, or good management. 

The GMP is generally very less for IPOs that have little to no demand. This could be because either the company is not too renowned or because it has a bad reputation in the market. 

FAQs

Q. Are the trades in the grey market honoured?

More often than not, the trades are honoured, which is why the market works even today, despite being unofficial. However, there have been a handful of major defaults. One such instance was during the listing of Reliance Power. An overwhelming majority of traders had gone long on the stock, but the stock fell on listing. This resulted in the traders reneging on their promise. After this event, the market witnessed comparatively lower activity for a couple of years.

Q. How are IPO applications traded in the grey market?

The process of trading IPO applications is very similar to that of shares. The only difference between the two is that the seller will get the premium even if the application is rejected. 

Q, How should you begin trading in the grey market?

You cannot trade in the grey market like you would in the official market. You can’t trade via phone calls or brokers or over the internet. If you want to trade in the grey market, you will have to locally connect with a dealer who can get you in touch with buyers and sellers of the grey market.