What is the Grey Market Premium?

Grey market premium or GMP is an amount paid at which initial public offering (IPO) shares are traded before it is listed on the stock exchanges. In simple words, it is the difference in price between shares of a company traded on the grey (unofficial) market and their expected listing price on the stock exchange. Therefore, many investors consider GMP closely as it tells them how interested the market might be or how much they will like to buy at that time of issuing new stocks. However, because there is no formal regulation for this indicator, one should note that this statistic remains somewhat informal. However, knowing GMP can help people who invest to measure market sentiment before an IPO goes live on exchanges. In this blog, you will understand the factors influencing it, its significance, and how IPO shares are traded in the grey market.

Key Highlights

• GMP is a term used to describe how much the trading prices of shares in the unofficial grey market differ from their expected listing price at the stock exchange, and it indicates market sentiment before an IPO takes place.

• Several factors influence GMP including market sentiment, company fundamentals, industry sector, reputation, and IPO size. 

• GMP serves as an indicator of investor confidence, helps in risk assessment, and influences investment decisions regarding potential pricing and volatility expectations before an IPO.

• GMP is equal to grey market price minus issue price providing some insights into market trends but still operates out of the formal regulations and needs caution when using it.

Factors Influencing Grey Market Premium of IPO

Many things that are influenced by stock market expectations and the feelings of buyers about variability in their shares lead to Grey Market Premiums (GMP) for IPOs. Let’s discuss them in brief:

Market Sentiment

Market expectations, which express either the investor’s optimism or pessimism are strong driving forces on the Grey Market Premium (GMP) of IPO shares. When shares are highly expected by investors in the grey market it leads to the increase of GMP often interpreted as high demand. Whereas, bearish conditions are characterised by low investor confidence resulting in decreased or negative GMP that reflects little interest and weaker debut activities.

Company Fundamentals

The grey market premium (GMP) of a company is significantly affected by its financial condition. Companies with strong finances and suitable market growth chances will attract higher GMP. Due to this investors will feel secure about their money in these companies. Whereas, poor finances or unpredictability would also imply lower GMP. This gives an impression that investors may not be interested anymore or they could be careful about the market.

Industry and Sector

The grey market premium (GMP) of a company is significantly affected by the industry or sector in which it operates. For example, high-growth sectors like healthcare or technology tend to have high GMPs. This is because they are perceived to have better prospects. Whereas, traditional or slower-growing sectors may have lower GMPs signalling modest investor excitement.

Company Reputation

A company’s reputation is fundamental to the determination of its grey market premium (GMP). Companies that have good records and ethical practices usually enjoy higher GMP because they can gain more trust among investors. Whereas, companies with poor reputations may encounter lower or even negative GMP which shows doubt from investors.

Size of the IPO

The GMP is greatly impacted by the size of the IPO. Smaller IPOs tend to have highly-priced GMPs because of their limited availability.  This results in an increase in demand and competition for investors. However, with larger IPOs, it is not unusual for them to observe half price or even lower due to the large number of shares available. Hence, it loses its unique identity adjusting itself to what investors are looking for in the market.

How to Calculate the Grey Market Premium?

Grey Market Premium (GMP) is one of the best ways to assess the market sentiment for an Initial Public Offering (IPO) before its listing on the stock exchange. In simple words, IPO GMP is the disparity between the trading prices of shares in grey markets and their offer prices as determined by issuing companies.

Here is the formula for GMP calculation:

GMPR = Grey Market Premium * Number of shares 

To calculate the GMP, you need to follow these simple steps:

Gather information

Collect particulars concerning the IPO – the amount of shares provided and the issue cost. At the same time, look for the existing GMP in the market for those shares.

Determine the GMP

To calculate the GMP, subtract the issue price from the grey market price. 

For example, when the issue price stands at Rs 100 for each share while the grey market price equals Rs 102 for every share, then the GMP amounts to Rs 2 only. However, when many transactions normally occur at prices that exceed the initial offer price shares traded on a secondary market are said to be selling at a premium over their face value. 

It also happens due to higher demand than supply of IPO shares and it shows little about buyers who want one; therefore grey market premium acts as a barometer for gauging public opinion or investor perception regarding an IPO’s prospects in general.

Calculate the GMP Percentage

The GMP can be expressed in percentage terms by dividing it by the issue price and multiplying by 100.

For example, 2 / 10 x 100 = 20%. The corresponding indicator or how well share prices may change in future after going through an IPO is sometimes referred as GMP. 

However, let’s keep in mind that the grey market isn’t controlled by any stock exchange systems. Thus they are completely separate things. 

So you cannot expect it to provide clues about what might happen once these shares get listed on some other official platform. Therefore, those who make decisions based on GMP should take into consideration its rarity to safeguard themselves from potential loss.

Significance of IPO GMP in the Stock Market

IPO GMP acts as a catalyst in stocks providing valuable insights on how investors feel, what they want, and how well the company listed will thrive. Let’s discuss its significance in brief:

Indicator of Market Sentiment

IPO GMP represents how investors feel about an IPO that is about to come up and it will show what was expected as demand and how confident people are about the company. A positive GMP expresses belief, whereas a negative GMP portrays doubt. Thus, providing investors with an insight into the market conditions before they decide to invest.

Risk Assessment

Measuring the market sentiment toward the IPO’s risk profile aids in making investment decisions. A high propensity for caution would be prompted by negative or low GMPs. Whereas, a strong demand and lower perceived risks are indicated by positive GMP.

Profile Potential

In the short term, an IPO GMP can be taken as a pointer for making profits. An increase in GMP indicates that there will be high demand. This means that buyers will get involved in an initial public offering (IPO) to enjoy the subsequent rise in price after it has been listed.

Investment Decision

GMP of IPO influences the investment decisions, as it indicates a possible gain after listing. A high GMP will attract investors, whereas a low or negative GMP will chase them away. The final investment decisions should be made after careful study and other considerations.

Pricing Trading

The worth of a firm is revealed before an IPO is launched. This helps enhance pricing transparency for the General Meeting of Producers. In this manner, it helps the investors to determine how much a company is valued according to the market. This leads them to select better investment decisions and make comparisons with similar industries.

Benchmarking

Investors use the initial public offering government-mandated price to compare with historical premiums of similar companies. Such a comparison enables one to establish whether an IPO is fairly priced compared to others. Thereby helping investors to determine its attractiveness in the market.

Volatility Expectations

IPO GMP shows the expected price fluctuations after listing. For example, a high GMP may mean price variations in the short term. Whereas, low or negative GMP means that a stock will have a stable debut. Therefore, investors are advised to evaluate their risk appetite for those IPOs that have high GMP.

How are IPO Shares Traded in the Grey Market?

The following steps are involved in trading initial public offering (IPO) shares on the grey market:

• Just like shares traded during an IPO, both buyers and sellers are involved in grey market applications for IPOs.
• Based on market conditions and their assumptions, buyers determine what to pay for an application while offering sellers a premium for their smart work.
• Some sellers may even decide to sell their applications through grey market dealers as a precautionary measure against any unforeseen circumstances that could lead to dire financial losses.
• It is worth adding that these sellers do not lose anything because they will still get the agreed premium whether or not they receive share allotments at all.
• In turn, the dealer passes on the details of such transactions to the buyer who can act accordingly.
• The issuer’s registrar determines how many shares are allocated or sometimes none at all may be given to the sellers.
• When shares are allocated and sold then it is either transferred to the Demat account or sold as per the agreed price.
• This process is quantifiable by either profit or loss calculation if they sell shares.
• However, in this scenario, premiums are still paid to sellers despite no allocation of any shares going to them through sale.

Conclusion

The grey market premium (GMP) is an important element for knowing the attitude of the market towards an IPO before its official listing. It gives insights into the investors’ feelings, possible demands, and risk evaluations that help them to make smart decisions. Nevertheless, because it functions outside of formal regulations, caution must be exercised when dealing with GMP to be paired with other factors and complete investigation. Investors can use GMP as a tool for evaluating it together with company fundamentals, industry patterns, and market circumstances to understand the complex IPO investment process, which may enable them to increase returns while decreasing risks at the same time.

FAQs on Grey Market Premium