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Business News/ Markets / Grey market: What is it? Should you trade in grey market and other questions answered
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Grey market: What is it? Should you trade in grey market and other questions answered

Grey market is considered to be a strong indication of whether a stock will be listed at a premium or a discount.

Grey market is a place where shares of a company are bought and sold outside the official trading channels. Photo Credit: Unsplash (Photo by Alexander Schimmeck on Unsplash )Premium
Grey market is a place where shares of a company are bought and sold outside the official trading channels. Photo Credit: Unsplash (Photo by Alexander Schimmeck on Unsplash )

In the last few days, the investor community has been awash with reports of LIC shares quoting at a discount in the grey market. As per the latest reports, the LIC share price is quoted at a discount of ₹25 in the grey market on May 13. The stock of Life Insurance Corporation (LIC) of India may get listed on May 17, 2022, on BSE and NSE.

Shares of LIC have been in trade in the grey market An IPO grey market. How? Because it is possible to trade in unlisted stocks before they are even issued by the company in an Initial Public Offering (IPO). Since this is an unofficial market, there are no rules and regulations.

The grey market is considered to be a strong indication of whether a stock will be listed at a premium or a discount.

For investors, who are new to the world of investing, the grey market may sound like an alien term. These may be some key and basic questions that one would want to know. Let's try to clear the basics of the grey market trade.

What is the grey market?

In simple words, it is an unofficial, unregulated market where financial securities are traded which is why it is also called the grey market, or the parallel market.

So, it is a place where shares of a company are bought and sold outside the official trading channels and it does not fall under the ambit of market regulator SEBI so it is a risky place to be in.

Even though it is not regulated, it is not illegal. The factor that makes it 'grey' is that it trades in even those financial securities such as stocks of startups that are not officially listed in the regulated market.

"Although grey markets are not illegal, they are not authorized or controlled in the usual way. That means SEBI, stock exchanges and brokers are not involved or back these transactions taking place in the grey market. Therefore, there’s little legal recourse available to parties if the stock tanks," Kotak Securities says.

How does it function?

One usually trades IPO applications in grey market normally after the application window is closed but before the allotment takes place. As Kotak Securities highlights, the seller transfers all the shares allocated to her to the buyer, regardless of what the listing price may turn out to be later and since this trade is not backed by SEBI, the buyer has no option but to trust the seller to honour her word.

It's a risky place with extreme potential for manipulation.

Umesh Paliwal of UnlistedZone (a startup that deals in pre-IPO shares), highlights that in times of a much anticipated IPO, there is strong activity in the grey market and there is a reason for it.

Many people participate in an IPO but not all get the share allotment. Here comes the grey market in the picture. Even if you get the allotment or not, you can earn money from the grey market because of your application.

"Let's consider one IPO has been concluded and now the share allotment and listing are to be done. Suppose you are demat holder and you want to sell your IPO application, you can sell your application to demat brokers. If you sell your application for ₹100, you get ₹100 even if you get a share allotment of a company or not. But if you got the allotment, then you will have to sell your shares in the pre-open session," Paliwal explains.

The price at which the applications are sold in the IPO market is called the 'Kostak' rate. So, naturally higher demand for an application means a higher Kostak price.

"There are no official people or businesses you can approach for IPO grey market trading. If someone is interested in buying or selling IPO stocks in the grey market, they have to find a local dealer who can find buyers or sellers for them," Akhilesh Jat, an analyst at CapitalVia Global Research, points out.

How can investors buy shares in grey market?

First, find a dealer or broker who buys and sells applications for the grey market.

The grey market is an over-the-counter market, so anyone interested in trading must find a local dealer who deals in such securities. There are many dealers, brokers and enterprises providing this service.

"There are no official people or businesses you can approach for IPO grey market trading. If someone is interested in buying or selling IPO stocks in the grey market, they have to find a local dealer who can find buyers or sellers for them," Jat explains.

Here, one should remember the fact called grey market premium (GMP) which is the premium that investors are willing to pay over the issue price. The issue price is the price at which shares are offered for sale before they are officially listed on the stock market.

What does grey market premium indicate?

Grey market premium indicates the approximate listing price for a particular IPO. In the case of LIC, the current GMP of LIC is at a discount which indicates that the LIC stock may list below its issue price.

So, the GMP helps to gauge the interest of investors in a particular IPO depending on whether it is negative or positive.

"GMP reflects on how the IPO might perform on listing day. As it is with stock prices, the grey market premium for an IPO is based on the demand and supply of the stock. If the subscription numbers for a particular IPO are less than the number of shares they have offered in the IPO, then the GMP will be lower. On the other hand, if the subscribers are higher than the number of shares they have offered in the IPO, the GMP will be higher," Santosh Meena, Head of Research, Swastika Investmart puts forth.

Should you trade in the grey market?

Market experts do not recommend trading in the grey market even though it is not illegal. This is because of its inherent grey nature. Since the market is not regulated, many things remain ambiguous. Prices can see wild swings, there is a lot of risk of manipulation and due to the absence of any regulator, there is no grievance redressal mechanism.

"Retail investors should certainly avoid the grey market. Listed securities have a regulatory system in place to protect the investors and also they enable the dissemination of adequate financial information to the investors. Grey markets lack both," says G Chokkalingam, Founder & Head of Research, Equinomics Research & Advisory Private Ltd.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies and not of MintGenie.

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Published: 16 May 2022, 07:38 AM IST
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