Gafar Market and Nehru Place in Delhi or Heera Panna Market in Mumbai have become household names across India. These are one of the most popular grey markets for electronics and software in the country. But grey markets are not limited to electronics and software, even stocks have grey markets. Grey market rates for unlisted companies or companies about to be listed are often sought by investors to get an idea of the script’s future performance.
What is the Grey Market?
Legally shares are traded in the primary and secondary markets, which is facilitated by the stock exchanges. New shares are created and sold to the public in the primary market. An initial public offering is an example of a primary market. After getting listed, the shares are traded in the secondary market. The trades that take place in the primary market and the secondary markets are facilitated by stock exchanges and regulated by the Securities and Exchange Board of India.
However, before being listed shares are informally traded in the grey market. The grey market for shares doesn’t is a closed, informal market that operates on trust rather than rules and regulations. The grey market is not regulated by SEBI or any other legal authority and any risks arising out of operating in the grey market has to be borne by the investor. The trades in the grey market are often carried through small chits of paper and unofficial dealers.
What is Grey Market Stock?
A grey market stock refers to the shares of the company that are traded unofficially. When a company’s shares are presented by traders before their official IPO, it falls into the category of grey market stock.
Generally, a limited set of individuals runs the grey market stock, and it works based on trust between the individuals. It’s important to note that trading in grey market stocks in India is both legal and unofficial. However, any transactions conducted in the grey market cannot be settled until the official trading through authorised channels commences.
Types of Trading in Grey Market
Trading in the grey market can be categorised into two types:
- Buying or selling the IPO shares that are allocated before they are listed in the stock exchanges.
- 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.
How does IPO Grey Market Work?
The grey market runs outside the authority of the stock exchanges or the SEBI. Let us try to understand how the grey market operates. Suppose the IPO of a company opens and Mr X applies for a certain number of lots in the retail category. At the application stage, Mr X has no idea about the chances of allocation. Another investor Mr Y is also interested in the shares of the company. Mr Y wants surety in the allotment and hence, doesn’t want to proceed through the official channels. My Y gets in touch with a grey market dealer to buy a certain number of lots in the IPO. The dealer contacts Mr X and concludes a deal with him. The dealer offers Rs 10 extra per share over the IPO price to Mr X.
Now, if Mr X agrees, he will have to sell all the shares to Mr Y at the IPO price + Rs 10, if he is allotted shares in the IPO. In the deal, Mr X will get a guaranteed profit of Rs 10 per share, irrespective of the listing price and Mr Y will get guaranteed ownership of the shares if Mr X is allotted the shares. If Mr X gets allotment, the dealer advises him to sell the shares to Mr Y at the agreed price. On the listing day, if the shares lists at a premium of over Rs 10 per share, Mr Y earns a profit and vice-versa.
What is GMP?(Grey Market Premium)
The grey market determines the share price of an IPO-bound company depending on the subscription data and investor sentiment. If the demand for shares is too high and the supply limited, the share quotes a premium over the allotment price. Buyers offer an additional amount over the IPO price to get the shares before listing. In the previous example, the additional Rs 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 below-mentioned formula for GMP calculation:
GMPR = Grey Market Premium * Number of shares
To calculate the GMP, follow these steps:
- 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.
- Determine the GMP: To determine the GMP, subtract the issue price from the grey market price. For example, if the issue price is Rs. 100 per share and the grey market price is Rs. 102 per share, the GMP would be Rs. 2. If the grey market price is higher than the issue price, the shares are said to be trading at a premium. It happens when the demand for the IPO shares is higher than the supply. It indicates the presence of more buyers in the market. The grey market premium is often used as an index for determining the market sentiment of the IPO.
- 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.
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.
As the grey market is outside the ambit of legal authorities, it is safe to stay away from it. However, the rates quoted in the grey market can be an effective indicator of the performance of an IPO. The GMP (Grey Market Premium) or the Kostak rate should be taken into consideration only to get an idea of a scrip’s future performance.
What happens if GMP is high?
The GMP does not directly affect the actual IPO price. However, knowing the GMP rate can help an investor predict at what price the IPO might be traded. Therefore, a high GMP may indicate that the price of shares in the IPO will also be high.
How does GMP affect IPO listing price?
The GMP does not directly affect the IPO listing price. The grey market premium is completely outside the ambit of legal authorities and the actual IPO process.
Is GMP a good indicator for IPO?
It depends on the level of expertise and knowledge of the people who are active in the grey market of IPO shares – they might be just like any retail investor. Therefore, GMP is not a reliable indicator of IPO prices.
How GMP is calculated?
The GMP is calculated based on assessments of investor sentiments and subscription data.