Understanding the Grey Market IPO—An Unofficial but Legal IPO

Most people have heard of black market buying and selling. It happens with exotic animals, drugs, and even securities. The gist of it is that the trading takes place illegally, but what happens when that line is blurred? When an IPO takes place unofficially but legally, you've got a grey market IPO.

Here's a quick explainer on the IPO grey market to help you understand what goes on before the market draws the curtains.

Before we dive into what an IPO grey market is, let's think about how a grey market might operate in a traditional merchandise setting. A small brick-and-mortar shop might sell products from a company, even though they aren't an "authorized dealer." However, they're still acting legally, which makes this a grey market situation rather than a black market deal.

The IPO works similarly. Before the company actually offers its IPO, it might participate in a grey market IPO where investors bid on shares unofficially. This usually takes place with insiders or institutional investors, since retail investors from the general public can't access a company's stock until it's on the market.

While this type of grey market isn't outright illegal, it also isn't regulated, which means that investors are placing a riskier bet simply due to a lack of authoritative protections.

So, why would investors do this? They're basically placing a bet on the company's potential market cap before the IPO goes through. In places like India (home of the Securities and Exchange Board of India, or SEBI), investors can commit to IPO investments ahead of time. This helps gauge interest, much like an IPO roadshow in the U.S.

Grey market IPOs tend to take place with intimate groups of investors, mostly because they're settled on trust rather than regulation.

In a grey market IPO, the GMP (grey market premium) refers to the price that the security is trading shares at before the actual public offering.

A GMP could be more than the stock's issue price. In this case, investors are expecting the company's market cap to rise. Through premiums, grey markets attempt to correctly value stocks.

A grey market IPO usually involves CFDs (contracts for differences). These financial instruments are a type of derivative that facilitates returns based on how close the actual outcome is to the estimated one. CFDs are inherently risky due to the product's lack of regulation, lack of liquidity, and the requirement to trade on margin (or debt).

Twitter (NYSE:TWTR) went public in November 2013 and conducted grey market trading beforehand. These traders were lucky that Twitter shares rose 65.67 percent in the coming months. That peak didn't last, and the shares didn't reach that level again until seven years later in February 2021.

Currently, Glenmark Life Sciences is preparing to go public on Aug. 6. In the grey market, it looks like the offering could produce returns in the long term, but the grey market premium is on a fast decline.

Grey market premiums prompt speculation from investors before the IPO takes shape. However, there's only one way to find out what will happen in a company's offering and that's to wait and see.