Gray Market: Meaning, Advantages, Disadvantages, Example and More

Gray Market: Meaning

Gray Market or Grey Market is a marketplace where goods and/or financial securities are traded in an unofficial manner. It is not an illegal market place but it is just an unofficial marketplace. In the case of the goods market, this market supplies goods of the authorized brands from authorized manufacturers but through an unauthorized delivery channel. In the case of the financial securities market, all those securities which are either barred from trading on the exchange or are yet not up for even an IPO, are traded in this market. All transactions in Gray Market are in cash terms without any regulatory or governing authority.

In Gray Market, trading of financial securities (both stocks and bonds) takes place through an Over-the-Counter (OTC) medium. The dealers are the ones who execute the orders, after giving customer preferences. In Gray Market, goods either imported or manufactured in the country are sold through a different delivery mode altogether. The selling of products at cheaper prices happens because of the price discrepancy of the same product in different markets. There are unofficial dealers in this market, who take benefit of this price discrepancy. These dealers orders in bulk and still manages to sell at prices lower than the market price even after adding their profit margins.

The other name of Gray Market is Parallel Market.

IPO Gray Market

Gray Market for financial securities is known as IPO Gray Market. In this market, all the transactions take place compulsorily in cash terms. This market is not regulated by statutory bodies like the Securities Exchange Commission (SEC) of the USA or the Securities Exchange Board of India (SEBI) or any other authority. This market completely works on the trust factor with a comparatively lesser number of people. There is no involvement of any stockbroker in this market. Only dealers operate in this market. In this market, either the securities suspended from the stock exchange are traded or the securities yet not listed or made public are traded.  

In IPO Gray Market, a premium price is charged for the securities which are yet not listed on the stock exchange. This premium is known as ‘Gray Market premium’ or ‘IPO GMP’. According to the demand and supply factors, the determination of premium price takes place. This premium can be negative or positive, depending on the investor’s sentiments. It gives an estimate to the investors and the issuer on the price estimates of the stock according to the supply and demand of the same.

 In IPO Gray Market, the fixed prices at which securities are sold even before getting  IPO allotment and listing is known as ‘Kostak Price’. The seller, sells the whole IPO application at a fixed price to the buyer, in this market. The seller does not wish to take the risk with regard to price fluctuation upon listing. And therefore he sells the entire quantity at a fixed Kostak Price. After the IPO allocation, whatever be the listed price would be, the deal in Gray Market would be settled at Kostak Price only. Many factors including supply and demand, determine the Kostak prices. 

Example

Let’s understand this, with an example:-

CompanyIssue Price/share ($)Gray Market Premium /share ($)Selling Price or Buying Price/share ($)
ABC Company20050250
XYZ Company200-40160

As shown in the above table, the investors are ready to buy shares of ABC Company with a price of $250 per share, with a positive premium of $50. In the case of XYZ Company, the issuers are ready to sell shares at $160 per share with a negative premium of $40. Negative premium acts as a discount in this market. The demand and supply factors determine the negative or positive premium in the Gray Market. This IPO GPM keeps on fluctuating till the final listing of shares happens on the stock exchange.

Gray Market

Advantages of Gray Market

  • IPO Gray Market allows the investors to back out of the IPO, even before its listing. The investors can take advantage of the price movement before its listing.
  • In the case of financial securities, this market provides the issuer and the underwriter with an estimated figure of share price and valuation before going public.
  • Such a Market of goods provides the same authorized product by the same authorized manufacturer at a discount price. Lower prices attract customers towards this market.
  • All those securities which have suspension from trading on the stock exchange get an opportunity to trade in IPO Gray Market.
  • This market helps the manufacturer in the short run. It helps the producer to enhance its incremental sales and gain profits from both unofficial and official distribution channels, in the short run.
  • Sometimes, official distributors are often the ones who are supplying goods to the Gray Market. Since they get bulk discounts from the manufacturers and in order to get rid of excess supply, they make a higher profit by supplying directly to Gray Market.
  • IPO Grey Market is the best market place for start-ups, to decide on whether to go public or not. It helps the startups in their valuation process. 

Disadvantages of Gray Market

  • The price estimates on the basis of the premium are not always reliable in the IPO Grey Market. Sometimes due to additional subscriptions from the institutional investors, there is a great influence on the price range.
  • As there is a very less number of people in the IPO Gray Market, the estimates not always show the true picture.
  • In the case of goods, since the delivery takes place through an unauthorized channel and dealer, there is no ‘After Sales Service’ for the customers.
  • Products under this market come up with a high risk. Irrespective of manufactured under the same brand same, it does not guarantee the quality of the products.
  • Gray Market of financial securities is not under any regulatory authority. This enhances manipulation and makes it risky.
  • Due to riskiness, many institutional investors like Pension Funds, Foreign Direct Investments (FDIs), Foreign Portfolio Investments (FPIs), Mutual Funds; etc avoids investing in Gray Market.
  • It negatively hampers the brand name of the manufacturer. If the product does not qualify the quality standards, ultimately the brand name of the manufacturers suffers.
  • Such unauthorized delivery channels also negatively impact the regular supply channel of the company which includes designated retailers, distributors, and wholesalers. Thereby hampering the price stability of products.
  • Official distributors of the company help in advertising and business development. Unofficial distributors of this market do not provide any such assistance to the manufacturer.

White Market Vs Gray Market Vs Black Market

All the above are the market places, functioning in a different way. White Market is the most common type of market. In this market, regulatory authority continuously watches all trades. Selling of all official products by the official manufacturers takes place in this market through official channels and so it is the least risky.

Black Market is the market place where all illegal activities take place. Smuggling of goods takes place in this market to avoid import duty or any other charges. While Gray Market is an unofficial but not illegal market. In conclusion, White Market is an authorized market, Gray Market is an unauthorized market and Black Market is an illegal market.

Gray Market Goods Vs Knock-off Goods

Knock-off goods are goods that are mostly illegal in nature. The trademarks and copyrights on the products are not the original given by the authorized manufacturer. In contrast to this, Grey Market goods have original trademarks and copyrights on them, but they sell without official approval.

Conclusion

Although Gray Market of goods and financial securities comes up with lots of criticisms, it is still one of the popular markets. It is beneficial for investors, dealers, issuing companies, startups, etc in one or another way. Grey Market allows startups and companies to test the waters before getting in to swim. It provides investors with a profit-making opportunity. All those securities which have been suspended from trading on an exchange, are given a platform to trade in IPO Grey Market. In the case of Goods Gray Market also, it boosts the sales of the manufacturer, provides goods at lesser prices to customers, helps the wholesalers and dealers, and many other benefits. And so Grey Market co-exists with Black and White Market in the economy.

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Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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