How does the Grey Market of IPOs Work?
In this article, We will discuss the Grey Market Premium of IPOs.
Anyway, before getting to the start of this article, Let me tell you “What is the Grey Market?“.
Grey Market [GM] also known as parallel market, is unofficial. However, it’s not an illegal stock market where traders do the trading.
This trading normally occurs, When existing stock is suspended or delisted from the market
or When new IPOs are bought or sold before the company stock is listed in the stock market.
Normally, issuers that decide to initiate an IPO decide to test the value in the grey market.
They do so for various reasons such as to verify the demand for the impending IPO or to gauge what the IPO valuation should be.
This market is an over-the-counter market where dealers may execute orders for preferred purchasers as well as provide support for a new issue before it is literally issued.
This task allows underwriters & the issuer to determine the demand of the company.
This assists them to get a sense of what the IPO(s) valuation can be.
Important Point: As Grey Market [GM] is an unofficial over-the-counter market, there are no regulations around it. Therefore, all transactions are made in cash on a personal basis.
SEBI i.e. Securities and Exchange Board of India, Stock Exchange, or any Brokers are not involved or back these transactions.
Basically, Two important terms used in the grey market are “Grey Market Premium [GMP]” and “Kostak“.
What is the Grey Market Premium(GMP) of the IPOs?
The Grey market premium [GMP] of IPOs is nothing but the price at which the shares are being traded in the grey market.
GMP is also known as grey market price, is a premium amount at which IPO shares are being traded in Grey Market before they get listed in the stock exchange.
The premium amount will be in rupee.
This premium price can be positive/negative based on the demand and supply of the stock.
GMPs are also attached with the words ‘Buyer’ or ‘Seller’.
They tell the price either at which buyers are willing to buy IPOs or the price at which sellers are willing to sell their IPOs.
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Types of Grey Market Trading
IPO GM involves two types of trading:
- Trading allocated IPO shares before they list on stock exchanges (selling or buying).
- Trading IPO applications at certain premium rate (selling or buying).
Also Read IPOs Definition | Types of IPOs | Fixed Price vs Book Building | Investors Types | Eligibility 2021
Example for Grey Market of IPOs
GMP is the extra money over the IPO price that investors are willing to pay to buy the shares.
If the GMP is high, more investors are likely to get involved with the IPO,
whereas a low/negative GMP indicates low interest and consequently fewer investors.
That means GMP helps underwriters to gauge the IPO price.
Let’s understand this with one example.
- Positive grey market premium
XYZ Limited
Issue Price: Rs 540 per equity share
GMP Price: Rs 500 (Buyers)
This means buyers are ready to buy XYZ shares at 540+500 = Rs 1040. - Negative grey market premium:
ABC Limited
Issue Price: Rs 50 per equity share
GMP Price: Rs -5 (Seller)
This means sellers are ready to sell ABC shares at the discount of Rs 5. i.e. 50-5 = Rs 45.
Also Read: How to Apply for IPO and FPO in SBI Bank (ASBA)?
What is Kostak?
KOSTAK is also known as “price of application” is the premium amount (Rupees) at which IPO applications are being traded in Grey Market.
Generally, this value is defined as the premium of a max lot retail application in an IPO.
if you have a Demat a/c but you don’t want to subscribe to an IPO, you can sell your IPO application to an interested buyer in the grey market.
Under these conditions, Your IPO application will be subscribed by the buyer on your behalf and she/he will pay you certain money for that. The profit you make is kostak rate.
Kostak rates vary depending on the IPO.
The main benefit is that the buyer may gain/lose her amount, but you will get a fixed kostak rate.
How can I Buy and Sell IPO Application in Grey market?
Grey Market is unofficial. Therefore, there is no official individual or business associated with the grey market.
If you are interested in buying or selling IPO stocks in Grey Market, you have to find a local broker.
These brokers, who buy and sell IPO applications on Kostak Rates based on the GMP.
The Bottom Line
The IPO grey market that performs outside SEBI’s purview. Therefore, there are no guarantees. All transactions are undertaken on the basis of trust and carry risks.
Aside from, a grey market could be used to gauge how the company’s stock will perform once it is listed.