What is GMP in IPO?

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  • 12 Jun 2023

In stock trading, you must be familiar with the primary and secondary markets. The Securities Exchange Board of India (SEBI) regulates and oversees both of these markets. In the primary market, companies launch their shares for the first time, 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.

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.

In the stock market, the Grey Market Premium (GMP) in an IPO represents the difference between the initial offering price of newly issued securities or commodities 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) = GMPR / Q

Here, GMP represents the Grey Market Premium, GMPR is the calculated premium, and Q denotes the number of shares sold in the primary market. 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 Rs. 100 per share and the grey market price is Rs. 105 per share, the GMP would amount to Rs. 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. For instance, in the example provided, the GMP percentage would be (5 / 10) x 100 = 50%.

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 capitalizing 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 appreciation in value.

Considering the grey market premium becomes an important factor in assessing whether an IPO will yield favorable 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, recognizing the value of getting in early, display a heightened 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 a 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

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 behavior once listed on the official exchange.

FAQs

The grey market premium refers to the premium at which shares of an IPO trade in the unofficial and unregulated grey market before their official listing on the stock exchange.

It is determined by the forces of demand and supply in the unregulated market. It reflects investor sentiment and market expectations regarding the IPO's future performance.

A positive grey market premium suggests that IPO shares are trading at a premium in the Grey Market, indicating strong investor demand and potential listing gains.

A negative grey market premium implies that IPO shares are trading at a discount in the Grey Market, suggesting limited interest or weak demand for the shares.

The premium can be volatile and may fluctuate significantly, leading to potential losses if the share price drops after listing. Additionally, since grey market trading is unregulated, there is a higher risk of fraud or manipulation.

While grey market premium can reflect investor sentiment and demand for an IPO, it may not always accurately indicate a stock's future performance. Various factors can influence the stock's price once it is listed, and it is important to conduct thorough research and analysis before making investment decisions.

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