Gray Market Stocks: Definition, Function & Risks

Gray-market stocks are those traded before the initial public offering.

The gray--or "grey"--market for stocks refers to an unregulated marketplace for stocks where brokers buy and sell shares of a company before it is listed on a regular stock exchange. Gray markets are legal in the United States and most of the world, although they are less frequent in this country.

Function

Companies preparing an initial public offering often use the prices from the gray market to set the value for their IPO, according to Investopedia.com. They can also fix any investor concerns before the stocks are publicly traded.

Features

In order to buy a stock on the gray market, the buyer must know somebody associated with a business. Unlike a normal trading place, such as the New York Stock Exchange, there is no central clearinghouse for the gray market. It is not illegal or "inside trading"--buyers are purchasing the right to buy stock yet to be issued.

Considerations

Gray-market stocks are much more risky than a normal stock purchase. This type of stock market is not subject to government oversight and little information on true market prices exists.

Benefits

Purchases in some gray markets around the world prove highly profitable. Vietnam's gray market, for example, is larger than its official stock markets, and some deals have doubled the value of the investor's holdings immediately.

Geography

Gray-market stocks typically occur outside of the United States. In this country, the closest thing to a gray market security is a "when-issued" stock. These usually occur when a company creates a spin-off firm and only lets investors of the parent company purchase shares before the IPO.