What is GMP in IPO?

If you are in stock trading, you must be familiar with the primary and secondary markets. The Securities and Exchange Board of India (SEBI) regulates and oversees both of these markets. In the primary market, companies launch their Initial Public Offerings (IPOs), and potential investors subscribe to them.

Subsequently, these shares are listed on the stock exchange, known as the secondary market, where they can be freely traded. Therefore, SEBI plays a crucial role in ensuring the smooth functioning of these two markets. However, there exists another market that operates informally, based on trust, and is not regulated by SEBI. This market is called the grey market.

What is Grey Market?

The grey market for shares operates as a closed, informal market, relying on trust rather than rules and regulations. SEBI or any other legal authority does not regulate the grey market, and investors must bear any risks associated with participating in it. Trades in the grey market often occur through small chits of paper and involve unofficial dealers.

What is Grey Market Premium?

In the stock market, the Grey Market Premium (GMP) in an IPO represents the difference between the initial offering price of newly issued securities to the public and the price of the same security when traded on a stock exchange or other accessible trading venue.

According to the definition, an IPO is initially sold at a fixed price in its primary market. However, when the IPO is listed on the stock exchange, it can be traded at a different price, which is referred to as the GMP.

Calculation of Grey Market Premium

You can use the following formula to compute GMP:

Grey Market Premium (GMP) = Grey Market Price – IPO Issue Price

To compute IPO grey market premium, keep in mind the following things:

• Gather Information: Gather information regarding the IPO, including the number of shares offered and the issue price. Additionally, determine the prevailing grey market premium in the market for the same shares.

• Determine GMP: Subtract the issue price from the grey market price. For instance, if the issue price is ₹100 per share and the grey market price is ₹105 per share, the GMP would amount to ₹5. When the grey market price surpasses the issue price, it indicates that the shares are trading at a premium. This situation occurs when the demand for IPO shares exceeds the supply.

• Compute GMP percentage: To express GMP as a percentage, you can calculate it by dividing the GMP by the issue price and then multiplying it by 100.

Steps to Trade IPO Shares in the Grey Market

The steps involved in trading IPO shares in the grey market are:

Step 1: The first step is to find a trusted grey market dealer. Choosing a dealer is crucial if you want to buy or sell IPO shares in the grey market.

Step 2: Based on the demand and IPO subscription, the dealer will quote a grey market premium.

Step 3: If both parties agree, they enter a contract. Buyers look for shares that they believe will trade above their issue price.

Step 4: The dealer, then, contacts sellers who applied for IPO shares and asks them to sell at a premium price.

Step 5: On receiving the application details, the dealer notifies the buyer of the purchase.

Step 6: If shares are allocated, sellers sell them at the agreed price or transfer the shares to buyers’ Demat account.

Step 7: If no shares are allocated, the deal gets cancelled but the seller still receives the premium.

Role of GMP in IPO Process

GMP plays a significant role in the IPO process. It provides valuable insights into investor sentiment, market trends, and expectations regarding the potential listing price of the IPO. If the GMP is high, it indicates strong investor demand and positive market sentiment. While a low or negative GMP indicates weak demand or doubts about the IPO’s performance, the positive or negative GMP can help investors make informed decisions, such as applying for an IPO or waiting for a more favourable market condition.

Investor and analysts closely monitor IPO GMP as it can provide insights into market trends, investor sentiment, market volatility, and overall market conditions. It also helps predict listing price. It gives investors a rough estimate of the expected listing price of the IPO.

IPO GMP Meaning in Stock Market

The main objective of grey market premiums is to grant early access to highly sought-after IPOs before they become available to the general public.

Buyers secure shares of these high-demand IPOs at pre-determined prices, while sellers profit by capitalising on the demand. These sellers take advantage of buyers who would otherwise have to purchase the shares after the official listing at a higher price.

Since the introduction of follow-on public offerings (FPOs), the existence of grey market trading has been anticipated, although it may be prohibited or restricted for certain IPOs. This form of trading enables investors to gain early access to shares of promising companies that are expected to experience value appreciation in future.

Considering the grey market premium becomes an important factor in assessing whether an IPO will yield favourable returns or not.

Parameters for IPO Grey Market Premium

Confident institutional investors willingly pay a price higher than the IPO price, leading to the grey market premium.

Investors engage in this type of trading by purchasing new shares released by companies exclusively for select private clients. Retail investors, recognising the value of getting in early, display an increased demand for these shares and are willing to pay a premium. Consequently, this presents an excellent opportunity for value investors to invest in the IPO listing before it becomes publicly available.

The magnitude of the grey market premium tends to be more substantial in IPOs experiencing high demand within a short timeframe. Such demand may arise due to factors like an intriguing business model, unique assets, or strong management.

Conversely, IPOs with little or no demand typically exhibit a smaller grey market premium. This could be attributed to factors such as the absence of tangible assets supporting the company or its negative reputation within the market.

IPO GMP Significance for Investors

• Retail Investors: Retail investors who have not been allocated IPO shares through the official subscription process often look to the Grey Market Premium as an indicator of the IPO's potential performance. A high GMP might signal strong investor demand and the possibility of listing gains, while a low or negative GMP could suggest limited interest.

• Institutional Investors: Institutional investors closely monitor the Grey Market Premium to gauge market sentiment and assess demand for an IPO. The premium can influence their investment decisions, allocation strategies, and pricing expectations.

• Speculators: Speculators and high-net-worth individuals actively participate in the Grey Market, aiming to profit from short-term price movements. They buy shares at a premium in anticipation of a higher premium or sell at a discount if they expect a decline in the GMP.

In Conclusion

So, what is GMP? The grey market premium in IPOs provides valuable insights into investor sentiment and market expectations surrounding an upcoming IPO. It acts as an unregulated barometer, reflecting the demand and supply dynamics of IPO shares before their official listing.

Investors, both retail and institutional, closely monitor the GMP to assess the IPO's potential performance and make informed investment decisions. However, it is important to note that Grey Market trading involves risks and uncertainties, and the GMP may not always accurately predict the stock's future behaviour once listed on the official exchange.