Grey Market – Definition, Types, Terminologies & Process

Grey market or parallel market is a market for trading stocks and applications before their official launch. This is an unofficial market and trading is mostly done through cash and in person. There is no involvement of third-party institutions such as Stock Exchanges or regulatory bodies like SEBI. In India, two of the popular terms related to grey market IPO or Initial Public Offering include Kostak and Grey Market Premium.

Grey market in India Explained

Grey markets have long been in existence in India as parallel markets for trading stocks. These markets primarily function on the demand and supply situation to allow traders and retail investors to trade in shares before these are actually listed.

Here are some of the instances when investors can use the grey market for investments:

1. If an investor has invested in an IPO and wants to exit it for some reason, the grey market can provide an opportunity to do so.
2. Investors can also buy IPO shares through the grey market despite missing the IPO deadline.
3. Before listing its stocks and applications, a company can trade the same in the grey market.
4. Grey markets also allow underwriters to better understand a company’s path once it is listed. Many unlisted shares in India reportedly trade at 15-20 times higher than their projected IPO price.

Grey market terminologies

Grey market stock

A grey market stock is a company’s stock that is unofficially offered and bid by traders. If a company chooses to offer its stock in the grey market before the shares are issued through Initial Public Offering or IPO, it is known as a Grey Market Stock.

A very small set of traders deal in the grey market stock and such trades are carried out based on mutual trust among individuals. In India, this type of trading in the grey market stocks is not considered illegal but is not regulated by SEBI. Such trades cannot be settled until the commencement of official trading.

Grey market premium

The price commanded by IPO shares in the grey market is known as grey market premium. The stocks of a company that comes up with an IPO may be bought and sold in parallel to the official stock markets. With the help of grey market premium, investors and other stakeholders can gauge how the IPO will perform on its listing day.

Let’s take an example to understand how the grey market premium works. Suppose the issue price of a stock A is Rs. 200. The grey market premium for the same is Rs. 300. This indicates that investors are willing to buy the shares of Company A at Rs. 500 (200+300). Thus, the grey market premium of any IPO will depend on its demand.

What is the process of trading in IPO shares through the Grey Market?

Here are the key steps involved in the trading of IPO shares in a grey market:

• Investors first apply for shares through IPO. While doing so, investors take on some amount of financial risk, as shares may be allocated below the issue price. These investors are sellers in the grey market.
• Some investors may find the share value to be higher than its issue price. Therefore, they take these shares before allocation via IPO allotment process. These sets of investors form the buyers in the grey market.
• The buyers in the grey market place an order for IPO shares at a percentage premium.
• Dealers in the grey market will then reach out to the sellers who would have applied for IPO and request them to sell their stocks at a grey market premium.
• Sellers who want to avoid the risk of stock market listing may sell their IPO shares to a grey market dealer.
• The dealer then notifies the buyer about the shares purchased.
• If the seller gets allotted the IPO shares, he/she can decide whether to transfer it to the buyer’s Demat account since most grey market deals are based on trust.
• The deal is considered canceled in case no shares are allocated to the seller.

Types of trading in grey market

In India, there are a few types of trading that take place in the grey market:

1. IPO Grey Market Trading: This type of trading involves the buying and selling of shares of a company before they are listed on a stock exchange. This is usually done through unofficial channels and at prices that are not regulated.
2. Unlisted Shares Trading: This involves trading in shares of companies that are not listed on any stock exchange. These shares are usually bought and sold through unofficial channels and are not subject to the same regulations as listed shares.
3. Penny Stock Trading: This refers to the trading of shares of small companies that are often not listed on a stock exchange. These shares are traded at very low prices and can be very volatile.
4. Commodity Trading: This involves the trading of commodities such as gold, silver, and crude oil. This type of trading is often done through unofficial channels and at prices that are not regulated.

Adverse impact of grey market trading on businesses

Here are some of the adverse impacts of grey market trading on businesses in the context of stock markets:

1. Lower Valuations: Grey market trading can lead to lower valuations for companies as unofficial trading can be influenced by factors that are not related to the company’s fundamentals. This can make it harder for companies to raise capital or attract investors.
2. Loss of Control: Companies can lose control over their share price when shares are traded in the grey market. This can lead to wild fluctuations in the share price that are not related to the company’s performance.
3. Legal Issues: Grey market trading can be illegal and can lead to legal issues for both companies and investors. Companies can face regulatory scrutiny and investors can be at risk of fraud or other legal issues.
4. Lack of Transparency: Grey market trading is often conducted through unofficial channels and lacks transparency. This can make it difficult for investors to understand the true value of a company’s shares and can lead to misinformation and speculation.
5. Reputation Risk: Companies can suffer reputational damage if their shares are traded in the grey market. This can lead to a loss of investor confidence and can impact the company’s ability to attract customers and partners.

Conclusion

Grey market is mostly used as an indicator by investors of near-future stock performance once it is listed. But you should bear in mind that the grey market is an unofficial channel and regulated members like SEBI, brokers or any investment platform are not involved in the grey market and hence it comes with its own set of risks. It helps buyers and sellers as much as companies while issuing an IPO to gauge the market sentiments and avail benefits of price discovery.

FAQs

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