All you need to know about the IPO Grey Market Premium

A grey market, also known as parallel market, is a marketplace for selling or purchasing goods outside the realm of the manufacturer’s official trading channels. For example, small dealers often sell branded apparel or footwear even though they are not authorised retail sellers of that brand. However, the grey market is not illegal (unlike the black market); it is just an unofficial channel for trading goods.

There is a grey market in the stock market ecosystem as well, for selling and purchasing stocks. This is different from the primary market (where stocks are sold for the first time through an Initial Public Offering or IPO) and the secondary market (where stocks are traded regularly by investors). Read on to know more. 

What Is the Grey Market and how does it work?
 

The primary and secondary markets are regulated by the Securities and Exchange Board of India (SEBI) and the various stock exchanges. But before IPO shares are listed and traded in the secondary market, they can be purchased unofficially from the grey market. 

The IPO grey market is an informal or unofficial market that is not bound by stringent rules or regulations. It is not backed by the rules of the SEBI, and functions between closed groups. In simple terms, the grey market is a platform where buying and selling of securities takes place before they are officially issued on the stock markets.

However, any trading that occurs in the grey market cannot be settled until the official trading begins after the listing of the IPO. This may cause an unscrupulous party to renege on the trade. Due to this risk, some institutional investors, such as pension funds and mutual funds, refrain from grey market trading.

Next, there are two essential things to know about the grey market – grey market premium and Kostak rates. Let’s find out what each of these means.

What is the Grey Market Premium?
 

Imagine you are waiting for the launch of a new smartphone. You are aware there is a huge demand for that phone and that you might not be able to snag one on the launch date. Now, suppose you are reliably informed that you can get that same phone in the grey market if you pay a little extra. For example, if the original cost of the phone is Rs 20,000, you might have to pay Rs 25,000 to get it from the grey market. Many enthusiasts would leap at the chance.

Similarly, when a company decides to get listed on the stock market and launches its IPO, its shares start trading unofficially in the grey market. To purchase these shares (that are not yet listed on the stock market), you might have to pay an additional amount. This extra amount is known as the grey market premium. The premium is decided based on the subscription data of the company launching the IPO and the investor sentiment around it.

Factors that affect an IPO’s grey market premium
 

Many factors account for an IPO's grey market premium, including the issuing company’s financial background, promoter group, market buzz, and its subscription status in the primary market. The grey market will entail a premium over and above the allotment/issue price. It means that buyers who are willing to pay the extra price to buy the IPO shares before they are listed can purchase them from the grey market after paying the grey market premium.

For instance, if a company ABC fixes its IPO price at Rs. 90 per share, and its grey market premium is Rs. 50, those interested will have to pay a price of Rs. 140 per share to buy ABC’s shares from the grey market.

One may wonder why anyone would be willing to pay more to purchase IPO shares from the grey market. But there is some logic behind this. When a company launches its IPO, investors look at several factors, such as the company’s financial background, business domain, IPO price, etc. If the investors think that the IPO might generate huge profits, they subscribe to it. However, not everyone can get IPO shares as they are allotted through a lottery system. So, some investors purchase them from the grey market by paying a premium.

It is crucial to understand that not all IPOs will command a grey market premium. Only those that are oversubscribed will have a premium attached to their price. This is why grey market premiums are considered an accurate indication of the demand for a company’s shares. Of course, this is not entirely reliable as grey market sentiments can be easily manipulated. But it can still be used to get a sense of investors’ sentiments.

What are kostak rates?
 

The grey market allows investors to sell IPO applications at agreed prices to willing buyers. Moreover, they can charge a premium for this. The Kostak rate is the premium amount at which IPO applications are traded by investors in the grey market. In other words, it is the additional amount that an investor pays to the seller to apply for an IPO even before its listing. 

What is the difference between kostak rate and GMP?
 

Kostak rate and Grey Market Premium (GMP) are two terms that are closely related to each other. While GMP refers to the premium that an investor has to pay to buy IPO shares from the informal market, Kostak rate is the rate at which willing investors can purchase IPO applications in the grey market. Grey market not only allows you to buy IPO shares before the listing but also facilitates trading of IPO applications.

If you want to apply for an IPO through the primary markets, you can do so with the help of IDFC FIRST Bank’s ASBA platform. ASBA (Application Supported by Blocked Amount) lets you apply for an IPO without making any initial payment. It blocks the application amount in your bank account and releases it only after the allotment or non-allotment of shares.

Additionally, you can open a 3-in-1 Account from IDFC FIRST Bank and enjoy the benefits of savings, trading, and demat accounts under one umbrella, backed by the sterling reputation of IDFC FIRST Bank. 

Conclusion
 

While trading in the grey market can be quite risky, understanding how the grey market premium works can help you make better bets and predict the demand in the market. It can also help you decide whether you should subscribe to an IPO in the primary market.
 

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.