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What is GMP (Grey Market Premium) in IPO?

•6 min read•by Angel One
Grey market allows investors to trade IPO shares and applications unofficially before official listing. While not regulated, grey market trends such as GMP and Kostak rates assist investors in assessing market mood and listing expectations.
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The Grey Market Premium (GMP) is a critical, unofficial metric of Initial Public Offerings (IPOs). It provides early insight into investor enthusiasm. The "grey market" itself is an unregulated, off-the-books system where investors trade IPO shares and applications before official listing. This trading environment, while lacking regulatory oversight, generates key indicators like GMP and Kostak rates, which help assess market sentiment and predict potential listing performance. However, they must be interpreted with caution. 

Key Takeaways

  • Rising GMP often indicates major early interest, particularly among institutional investors 

  • Grey market activity tends to expand under positive market circumstances. 

  • Premiums may expose discrepancies between the official IPO price and actual investor demand. 

  • Pricing varies widely due to dealer-driven, unregulated grey-market networks. 

Understanding Grey Market and How Does it Work? 

The grey market refers to the unauthorised purchase and sale of IPO shares before they are officially listed on the stock exchanges. This unofficial ecosystem works outside of regulatory oversight and relies only on trust between buyers, sellers, and grey market dealers, Due to the lack of SEBI restrictions, transactions are conducted privately, frequently via word-of-mouth networks. 

Understanding how it operates is an important aspect of knowing what is the grey market. Investors who seek guaranteed shares before allotment can approach grey market dealers to buy IPO lots at a premium, whereas applicants can sell their future allocation for a predetermined profit.  

If shares are allotted, they are transferred at a predetermined price; otherwise, the seller keeps the premium. This technique assists investors in estimating market demand before listing, but it also poses significant risk owing to a lack of transparency. While grey market trends might provide insight into sentiment, they should not be used to substitute professional study or official statistics. 

Understanding Grey Market in India 

The grey market in India has grown into an unofficial parallel system in which IPO shares and applications are traded prior to their official listing. Unlike official exchanges, price is influenced by localised dealer networks that respond rapidly to rumours, subscription chatter, and market sentiment. 

The notion of the grey market in India stems from investors' desire to obtain allotments or lock in predetermined profits prior to listing. Although it gives early sentiment indicators such as GMP and Kostak rates, the lack of SEBI oversight renders it fundamentally dangerous. Investors should see grey market signals as supplemental information rather than final projections. 

Types of Trading in Grey Market 

Trading in the grey market can be categorised into two types:  

  1. Buying or selling the IPO shares that are allocated before they are listed in the stock exchanges. 

  1. Buying or selling IPO applications at specific rates or premiums. 

Steps to Trade IPO Shares in the Grey Market 

The process of trading IPO shares in the grey market involves certain steps as follows: 

  • Similar to IPO shares trading, IPO applications in the grey market involve buyers and sellers  

  • Buyers determine the application's price based on market conditions and assumptions, offering a premium to sellers 

  • Sellers may sell applications through a grey market dealer for added security. 

  • Sellers receive the agreed premium even if they don't receive share allotments. 

  • Sellers provide details to the dealer, who notifies the buyer of the purchase. 

  • Share allocation is determined by the issuing registrar, and sellers may receive or not receive an allotment of shares.  

  • If shares are allocated, sellers may transfer them to a Demat account or sell them at an agreed price. Settlement occurs based on profit or loss if shares are sold.  

  • If no shares are allocated, the transaction concludes without settlement, but the seller still receives the premium. 

Also Read, What is Demat Account 

GMP For IPO 

GMP for IPO refers to the difference between a share's unofficial grey market price and its official issuing price. This premium reflects how investors see the IPO's likely listing performance. When demand is high, buyers offer higher prices, which increases GMP.  

When sentiment declines, the premium falls or even turns negative. Monitoring GMP for IPO helps investors evaluate the general excitement for a public offering. However, because grey market activity is unregulated and sometimes affected by speculation, GMP should be considered as a guideline, not a guarantee, of listing gains. 

What is GMP? (Grey Market Premium) 

The grey market premium is the price at which the shares of an IPO-bound company are traded in the grey market. It reflects the expected listing price and investor sentiment. If demand for shares is high and supply is limited, the share trades at a premium to the allotment price. Buyers offer an additional amount over the IPO price to get the shares before listing.  

In the previous example, the additional ₹10 per share offered to Mr X over the IPO price is the Grey Market Premium. Shares of every company don’t command a premium in the grey market. If the response to the IPO is tepid, the shares may change hands at a discount in the grey market. Investors take cues from the GMP for the listing price and to gauge the overall response to an IPO. However, GMPs may not always be an accurate indicator, as the grey market is susceptible to manipulation. 

How to Calculate Grey Market Premium?

Once you have understood ‘what is GMP?’, you can use the concept to decide whether to buy an IPO. Grey Market Premium (GMP) is a good way to gauge the market sentiment for an Initial Public Offering (IPO) before it’s listed on the stock exchange. IPO GMP refers to the difference between the price at which shares are traded in the grey market and the issue price set by the company. 

Hence, we can use the following formula for GMP calculation: 

GMPR = Grey Market Premium * Number of shares  

To calculate the GMP, follow these steps: 

  1. Gather information: Collect information about the initial public offering - the number of shares offered and the issue price. Simultaneously, find out the prevailing GMP in the market for the same shares.   

  1. Determine the GMP: To determine the GMP, subtract the issue price from the grey market price. For example, if the issue price is ₹ 100 per share and the grey market price is ₹ 102 per share, the GMP would be ₹ 2. If the grey market price is higher than the issue price, the shares are said to be trading at a premium. It occurs when demand for IPO shares exceeds supply. It indicates a greater number of buyers in the market. The grey market premium is often used as an indicator of IPO market sentiment. 

  1. Calculate the GMP percentage: You can express the GMP in percentage by simply dividing the GMP by the issue price and multiplying it by 100. In the example above, the GMP percentage would be (2 / 10) x 100 = 20%. GMP functions as a key indicator of how the IPO may perform in the market. However, it's important to note that the grey market operates independently of the official stock exchange and is not regulated. It only represents market sentiment at a point of time and may not indicate the actual performance of the IPO after listing. Investors who base their investment decisions on GMP should, therefore, interpret it with caution. 

Also Read, What Is IPO 

What is Kostak Rate? 

The grey market is not limited to the trade of shares before listing. You can also buy or sell the application in the grey market. The GMP becomes applicable only when shares are unofficially traded. But what if an investor wants to bet on the application itself? The rate at which full IPO applications are sold in the grey market is known as Kostak rate. The Kostak rate is dependent on the allotment of the shares. 

Conclusion 

While the IPO grey market gives early indicators of investor mood, it remains an unofficial and extremely informal setting. Trends like the Grey Market Premium (GMP) and Kostak rates can help predict the demand for an IPO, but they should be used with caution. Because grey market deals are based solely on faith and lack SEBI regulation, prices might be impacted by speculation, manipulation, or restricted participation. 

For retail investors, the grey market should never be used as the only foundation for an investment decision. Relying entirely on GMP may result in excessive expectations, as listing prices sometimes differ from unofficial market projections. Instead, investors should consider the company's fundamentals, financials, industry forecasts, and general market circumstances before investing in an IPO. 

FAQs

The grey market pricing is impacted by demand and supply, subscription levels, general market attitude, anticipated listing gains, and industry forecasts. 

Applications are traded through dealers at a certain premium. The seller retains the premium whether or not allocation happens. 

Trades are conducted through unauthorised dealers who charge GMP and the grey market premium. Because the market is unregulated, investors rely on trusted local middlemen. 

GMP gives an early indication of demand, but it is not an accurate prediction. Listing prices can vary depending on market circumstances and actual investor engagement.

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