What is IPO Grey Market Premium?

The new year has just set in, and a chain of IPOs has already started raining in the stock markets. This is probably why every investor, or anyone interested in the stock market for that matter, is running into some or the other IPO or anything related to IPO, almost every day. Every time there is a new or upcoming IPO, it is possible that you might have also encountered the term grey market premium. 

At some point or the other in your investor journey, you might have come across some sentence which would have sounded like, "the grey market premium of X company's IPO is 40%".

So it is natural for you to wonder, "What is a grey market?" or "What is the grey market premium prior to the launch of an IPO?"

A typical example of a grey market is a shopkeeper selling goods which he is not authorized to.

Let's dive into the Grey Market and understand what it actually is. 

What is IPO Grey Market?

IPO grey market is a place where a company's shares are traded by traders informally. This happens before the shares are issued by the company in an IPO.

Since this is an unofficial market, there are no rules and regulations. Securities and Exchange Board of India (SEBI) are not engaged in these dealings. The regulator doesn't endorse this either.

As it is an unofficial market, there aren't any rules and regulations in the grey market. Market regulators like SEBI do not track these transactions. The regulators don't endorse this either.

The grey market is run by a small group of people. Trading is done based on mutual trust.

Typically, companies that choose to launch an IPO make a decision to test reality in the grey market. The company does this for fulfilling several motives; for instance; to ensure the demand for the awaiting IPO or to evaluate the IPO valuation.

Grey Market Premium (GMP)

Grey market premium is just the price at which the shares are being traded in the grey market.

For example, let's suppose the issue price for stock Z is Rs 100.

Now, if the grey market premium is Rs 200, then it means that an individual is ready to buy the shares of company Z for Rs. 300 (100+200).

This is how a typical transaction takes place in the grey market.

Let's understand this with other examples: 

• Presume that the issue price of Reliance Nippon is Rs.200. Reliance Nippon has a grey market premium of Rs.50. In the given condition, the GMP is positive. As the premium is positive, the shares of Reliance Nippon are traded at Rs. 200 + Rs. 50 = Rs. 250. 
• Now let's assume in this scenario, the GMP of Reliance Nippon is Rs. -30. The issue price is Rs. 200. as the grey market premium becomes negative, it denotes that the shares of Reliance Nippon sellers are being traded at a discount of Rs. 30, i.e., Rs. 200 – Rs. 30 = Rs. 170. 

The GMP is very volatile. Till the shares are listed for trading on the stock exchange, volatility in the grey market premium price persists. 

Why is Grey Market trading done?

Grey market has existed for a long time, plus many investors and traders swear by the grey market. The reason is that it provides a good chance for retail investors to purchase the shares even before it is listed; if the retail investors are assured that share value is going to increase in the near future. It is almost based on the demand and supply situation.

Another reason can be when traders want to exit the IPO even before it is listed on the stock exchange since the grey market provides them with a proper way out.

Moreover, it allows the investor to invest in IPO shares even if they have missed the application deadline or if they want to purchase more shares than the IPO application can provide them.

The reason why companies allow grey market trading?

Grey market trading occurs even before the company is listed on the exchanges. Frequently, underwriters use trading on these markets to estimate the accurate IPO valuation. These markets assist underwriters to get an overview of the demand and future pathway for the company after it gets listed on the exchanges.

Moreover, there is at least a 6 days delay before the listing on the stock exchanges. As time is money, underwriters are eager to initiate selling and thus, are keen to sell shares in the grey market.

What is Kostak Rate?

Kostak Rate is the income an investor makes by selling his/her IPO application even before share allotment or listing of the company's share.

It is beneficial for investors who don't want to take a risk with IPO allotment or from listing gains.

In layman's terms, if an investor has a Demat account but doesn't want to subscribe to an IPO, they can sell their application to an interested buyer in the grey market. Under this scenario, the IPO application will be subscribed by the buyer on the investor's behalf, and the buyer will pay the investor a certain sum for that. The profit made by the investor in this procedure is Kostak Rate.

Kostak rates differ subject to the IPO. The benefit of this is that the buyer may gain or lose his money in this procedure, but the investor will get a fixed kostak rate.

Important points 

• IPO grey market premium activities may shift instantly, and rates may be unstable. It is risky to build an investment decision based on grey market IPO rates. 
• IPO grey market premium rates are known from market intelligence. An important point to note here is that these IPO GMP rates may be varying on geographies and markets.
• IPO GMP is the rate of premium an IPO gets per share in the grey market.
• Kostak Rate is the sum an investor gains by trading his IPO application in the grey market. This sum is fixed regardless of allotment status or varying listing gains.

Closing Words

A grey market IPO is beneficial for various factions such as companies issuing an IPO, underwriters, start-ups, formerly big companies and most significantly, traders.

Even though the grey market is unauthorized, traders give an undertaking for it as they can buy shares that haven't been listed on the exchanges and there are potentials of the share price enhancing in future.

However, it is always wise to consider all aspects, risks and gains before investing, be it the regular market or the grey market.

Happy and wiser investing!