The term "grey market" typically refers to the unauthorised trading of securities or goods through channels that are not recognised or regulated by the official authorities. In the stock market, the grey market involves the buying and selling of shares outside the official stock exchange platforms.
Here are two common scenarios where the term "grey market" is used:
- Unofficial trading of securities: In the stock market, the grey market can refer to the trading of shares before they are officially listed on a stock exchange. This often happens through unofficial channels, and investors may trade these shares at prices determined by market demand and supply. Such trading is not regulated by the stock exchange or market regulators.
- Imported goods parallel market: In the context of imported goods, the grey market can also refer to the sale of goods through unofficial channels, bypassing authorised distributors or retailers. This can involve the importation and sale of goods without the proper authorisation or adherence to official distribution channels.
In both cases, the term "grey market" implies a lack of regulation and oversight compared to official markets. Participants in the grey market may take advantage of price discrepancies, but it also poses risks for investors and consumers as these transactions may not be subject to the same legal protections and regulations as those in the official markets. It is important for investors and consumers to exercise caution when engaging in transactions in the grey market.
How does it work?
Here is a breakdown of how the grey market works in the context of trading securities:
1. Pre-listing phase
The grey market activity usually begins during the pre-listing phase, before the company's shares are officially listed on a stock exchange. Companies planning to go public often conduct IPOs to raise capital by issuing shares to the public.
2. Unofficial trading
In the grey market, investors trade these yet-to-be-listed shares unofficially. This can happen through over the counter (OTC) transactions or other informal channels. Investors may enter into agreements to buy or sell shares at agreed-upon prices.
3. Determining prices
Prices in the grey market are determined by market forces such as demand and supply dynamics. The perceived value of the company, investor sentiment, and other market factors influence the prices at which shares are bought and sold in the grey market.
4. Risk and speculation
Grey market trading involves a higher level of risk and speculation compared to trading on official stock exchanges. Since these transactions are not regulated, participants may not benefit from the same level of investor protection, transparency, or legal recourse in case of disputes.
5. Settlement process
Settlements in the grey market typically involve the exchange of shares and funds directly between buyers and sellers. The absence of a centralised clearing system can increase the risk of default and settlement issues.
6. Transition to the official market
Once the company's shares are officially listed on a stock exchange, the grey market activity diminishes, and trading transitions to the regulated exchange. At this point, the shares are subject to the rules and regulations of the official market, providing investors with the safeguards and transparency associated with established exchanges.
Additional read: What is Sensex
What is a grey market stock?
Grey market stock refers to shares of a company that are traded on the unofficial or grey market before being officially listed on a stock exchange. These shares are often part of an initial public offering (IPO) that has been announced but has not yet undergone the formal listing process. Investors interested in acquiring shares before the official listing may participate in grey market trading, where transactions occur outside the regulatory framework of established stock exchanges. Grey market stocks are essentially securities in transition, moving from private ownership to public trading.
What is the grey market premium?
The grey market premium (GMP) is a key metric associated with grey market trading, especially during the IPO phase. It represents the difference between the unofficial grey market price of a company's shares and the IPO price set by the company itself. In other words, the Grey Market Premium reflects the premium or discount at which investors are willing to buy or sell shares in the grey market compared to the IPO price.
- Positive GMP: A positive GMP indicates that investors are willing to pay a premium for the shares in the grey market, anticipating potential gains upon official listing. This suggests strong demand and positive sentiment surrounding the IPO.
- Negative GMP: Conversely, a negative GMP suggests that the grey market price is lower than the IPO price, signalling a lack of enthusiasm or concerns among investors. Negative GMP may be indicative of lower demand and a more cautious market sentiment.
Types of trading in grey market
The grey market offers two main types of trading for IPOs (Initial Public Offerings):
- Trading allocated shares: This involves buying or selling shares that have been allotted to you in the IPO before they are officially listed on the stock exchange.
- Trading applications: This involves buying or selling applications to participate in the IPO itself, at a premium or discount. Essentially, you are trading the potential of getting allotted shares.
Factors influencing GMP
- Market sentiment: Investor perception and sentiment play a crucial role in determining the grey market premium. Positive sentiment often results in a higher premium as investors anticipate strong performance post-listing.
- Company fundamentals: The financial health and prospects of the issuing company can impact the Grey Market Premium. Investors may be willing to pay a premium for shares of companies with promising growth potential.
- Overall market conditions: The prevailing economic and market conditions can influence the Grey Market Premium. During bullish markets, investors may be more optimistic, leading to higher premiums.
- Demand and supply dynamics: The basic principles of economics—supply and demand—also apply to the grey market. If demand outstrips supply, the Grey Market Premium is likely to be positive, and vice versa.
Understanding the Grey Market Premium provides potential investors with insights into market expectations and sentiment regarding an upcoming IPO. However, it is important to note that grey market trading involves higher risks due to the lack of regulation, and investors should exercise caution and conduct thorough research before participating in such activities.
How are IPO shares traded in the grey market?
The process of trading IPO shares in the grey market involves a series of steps that bridge the gap between the IPO application phase and the official stock market listing. Here is a detailed breakdown of the key steps in the grey market trading of IPO shares:
1. IPO application:
Investors who wish to participate in an IPO can apply for shares during the IPO subscription period. This involves submitting applications to the company or through designated intermediaries, such as banks or brokerage firms.
2. Risk and allocations:
Investors who have applied for shares in the IPO are taking a financial risk, as the actual allotment of shares may occur at a price below the IPO issue price. These investors are commonly referred to as "sellers."
3. Buyers identify opportunities:
Some individuals closely monitor the market conditions and may find the value of IPO shares to be greater than the issue price.
These individuals, known as "buyers," aim to collect IPO shares before the official IPO allotment process takes place.
4. Placing orders via grey market dealers:
Buyers interested in acquiring IPO shares before listing place orders through grey market dealers.
These orders specify the premium (additional amount) the buyer is willing to pay above the IPO issue price to secure the shares.
5. Dealer-seller interaction:
The grey market dealer contacts sellers (investors who applied for the IPO) and negotiates with them to sell their allotted IPO shares at a premium.
Sellers may choose to accept or reject the offer based on their assessment of market conditions and the premium offered.
6. Alternative sale to grey market dealer:
Sellers who do not wish to bear the risk associated with the stock market listing or have a preference for a fixed amount can opt to sell their IPO shares directly to the grey market dealer.
7. Notification to buyers:
Once the deal is finalised between the buyer and the grey market dealer, the dealer sends a notification to the buyer confirming the purchase of IPO shares and the agreed-upon premium.
8. Allocation outcome:
If the IPO shares are officially allocated to the seller, they have the option to decide whether to sell at the agreed-upon price or transfer the shares to the buyer's Demat account.
9. Automatic cancellation:
In cases where no shares are allocated to the seller during the official allotment process, the deal in the grey market gets automatically cancelled.
Understanding these steps provides potential participants in the grey market with insights into the dynamics of early IPO share trading. It is important for both buyers and sellers to carefully evaluate the risks and benefits associated with grey market transactions and to remain informed about the developments leading up to the official listing of IPO shares on the stock exchange.
Conclusion
The grey market is a marketplace for trading securities and goods outside of regulated exchanges. This can involve buying and selling stocks before they officially list or trading in imported goods that have not gone through official channels. While the grey market can offer opportunities to profit from price discrepancies, it also carries a higher risk of fraud compared to regulated exchanges. Be sure to carefully consider the risks before participating in the grey market.
