An Initial Public Offering (IPO) is a well-regulated process through which a company offers its shares to the public for the first time, thereby transitioning to public ownership. Through an IPO, shares of a company are listed on stock exchange/s in India. This allows the company to raise capital by selling ownership stakes to investors. On the other hand, an IPO grey market is an unofficial and unregulated platform where individuals can buy and sell shares of an upcoming IPO before they are officially listed on the stock exchange.

What is Grey Market IPO?

Grey market IPO refers to the buying and selling of IPO shares or applications before they are officially listed on the stock exchanges. The term “grey market” itself refers to an unofficial market where goods are sold outside of the official distribution channels. In the context of IPOs, the grey market operates similarly, where individuals engage in trading of IPO shares without the involvement of regulatory bodies or official exchanges.

In a grey market IPO, individuals trade IPO shares or applications without the oversight of regulatory bodies such as the Securities and Exchange Board of India (SEBI) or stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). This means that transactions in the grey market IPO are not governed by formal rules or regulations, and all settlements are made on a mutual basis between the parties involved. It’s important to note that while the grey market is unofficial, it does not necessarily mean it’s illegal; rather, it operates independently outside of the official market structure.

If you’ve ever purchased a product from an unauthorized dealer at a price lower than its MRP, you have likely participated in the grey market. Similarly, in the context of IPO shares, individuals in the grey market engage in trading before the shares are officially listed, doing so without the involvement of authorized exchanges and regulatory oversight.

However, it plays a significant role in providing insight into market sentiment and demand for upcoming IPOs, making it a crucial consideration for potential investors.

The grey market premium is the premium that investors are willing to pay for IPO shares over and above the issue price. Additionally, the Kostak Rate and Subject to Sauda represent the prices at which IPO applications or lots are traded within the Grey Market.

What is Grey Market Premium?

Grey Market Premium (GMP) refers to the premium at which shares of an initial public offering (IPO) are traded in the unofficial or grey market before their official listing on a stock exchange.

 In the grey market, investors can buy and sell IPO shares at a premium over the IPO price. For example, if a company sets the IPO price at Rs 200 and the grey market premium is Rs 50, investors would be willing to pay Rs 250 in the grey market to acquire the shares.

Conversely, if the grey market premium is negative, let’s say (Rs -50), it means that investors are willing to sell the shares at a discounted price of Rs 150. This indicates their belief that the shares may list at an even lower price.

The level of the grey market premium can offer insights into investor sentiment and expectations regarding the stock’s performance upon its official listing.

A high GMP suggests investors are optimistic about the stock’s potential to perform well once listed. At the same time, a low or negative premium indicates uncertainty or pessimism about its future performance.

It’s essential to note that the grey market premium is not constant and can fluctuate based on the demand for and supply of shares and overall market sentiment. Therefore, by analyzing GMP, investors can gain a preliminary understanding of how the stock might fare on its listing day. Additionally, it’s important to consider that fluctuations in the stock market can significantly impact premium prices.

What is IPO Kostak Rate?

IPO Kostak Rate, also known as the Grey Market Premium, is the profit earned by selling an IPO application in the grey market before the shares are officially allotted. For example, if a company sets an issue price of Rs 20,000 per lot and the Kostak rate in the grey market is Rs 2,000, it means that buyers are willing to pay Rs 22,000 (Rs 20,000 + Rs 2,000 Kostak rate) per lot in the grey market. The Rs 1,000 Kostak rate represents the seller’s profit, even if their shares are not allotted. If the shares are allotted, the seller keeps Rs 22,000 and gives the rest to the buyer if there is a profit. If the sale of shares is less than Rs 22,000, the buyer pays the difference. It’s important to note that approaching 50 people with Kostak rates does not guarantee allotment to everyone. To mitigate this risk, a “subject to sauda” clause is often applied.

What does “subject to sauda” mean?

The grey market is where unlisted securities are bought and sold. When discussing applying for shares through Initial Public Offerings (IPOs), the term “subject to sauda” means that the stated premium is applicable only if the applicant receives an allotment of shares.

This premium is typically higher than the Kostak rate. For instance, if you sell your IPO application in the grey market as “subject to sauda” for Rs 3,500, you will only realize this profit if you get the allotment of shares.

Sellers often opt for Kostak and are subject to sauda to secure profits before the shares are listed. On the other hand, buyers in this scenario are confident about potential listing gains and purchase the application in anticipation of a substantial return.

How does trading work with Grey Market Premium?

By Trading IPO shares

Trading IPO shares involves a process where investors who have applied for an upcoming IPO still determine the performance of shares upon listing. Therefore, they often turn to the grey market to sell their shares and potentially book profits. In this scenario, these investors act as sellers in the transaction.

Conversely, investors who believe the shares are undervalued and may list at a premium seek to acquire shares from the grey market. These investors act as buyers in the transaction.

Buyers usually get in touch with grey market sellers to buy stocks at a particular grey market premium (GMP). The dealers then approach sellers who have applied to sell the shares.

The deal is finalised if the buyer’s GMP is acceptable to the seller. Subsequently, the dealer collects the application details from the seller and informs the buyer about the purchase.

It’s important to note that the seller may or may not receive the allotment of shares. If the shares are allotted to the seller, they must either transfer them to the buyer’s Demat account or sell them in the open market and settle the difference.

On the other hand, if shares are not allotted to the seller, the deal is cancelled without any settlement.

By trading IPO Applications

When trading IPO applications, the transaction occurs between two parties – the buyer and the seller. The buyer’s outlook is optimistic, and they aim to purchase the entire application of shares. Conversely, the seller intends to secure profits before the shares are listed, a profit commonly referred to as the Kotak rate.

To negotiate the sale of the application, the buyer engages a grey market dealer who, in turn, contacts the seller. The seller is offered the opportunity to sell the application at a specified Kotak rate. By doing so, the seller effectively locks in their profit. Even if the shares are not allotted, the seller retains the Kotak amount.

The deal is finalised upon the seller’s agreement to sell the shares. The dealer then gathers the application details from the seller and notifies the buyer about the purchase.

If the shares are allotted, the dealer contacts the seller to request the transfer of the shares to the buyer’s Demat account or to sell the application at a specific price during the listing.

If shares are not allocated to the seller, the transaction is annulled. However, it’s important to note that the Kotak rate represents the seller’s profit.

How are traders in the Grey Market Taxed?

Regarding grey market trades, the seller must pay short-term capital gains tax on the profit generated from selling the shares upon listing.

To help you better understand, let’s consider an example. Let’s say you applied for an IPO with an application amount of Rs 15,000, equivalent to 50 shares at Rs 300 each. Subsequently, you sold the application in the grey market for Rs 4000. Fortunately, you received an allotment, and the shares were listed at Rs 600.

Following the agreement with the buyer, you sold the shares and received Rs 30,000. This led to a short-term profit of Rs 15,000. You would retain Rs 4,000 from this profit and pay the remaining Rs 11,000 to the seller in cash.

As the profit falls under short-term capital gains, you would be taxed at 15% of the total profit, resulting in a tax liability of Rs 2,250. Therefore, your net profit from this transaction would be Rs 1,750 (Rs 4,000 – Rs 2,250).

Frequently Asked Questions (FAQs)

Are Grey Market Trades legal in India?

Grey market trades, which involve buying and selling securities outside of the official stock exchange, are illegal in India. Financial Advisors highly advise against participating in any transactions within the grey market. These trades are typically based on trust, leading to significant counterparty risk. As no regulatory bodies oversee these transactions, engaging in grey market trading is risky.

What is the difference between grey market premium and listing price?

The Grey Market Premium (GMP) represents the difference in price between the initial public offering (IPO) issue price and the price at which the shares are traded in the unofficial or “grey” market before the IPO gets officially listed on the stock exchange. The listing price denotes the price at which the company’s shares are listed for trading on the stock exchange.

What do positive GMP and negative GMP indicate?

A positive GMP indicates that shares are being traded at a price higher than the issue price, suggesting strong demand and a potential for a significant gain on the listing day. For instance, if the issue price is Rs 500 and the GMP is Rs 150, the listing price might be expected to be Rs 650, reflecting a 30% gain.

On the other hand, a negative GMP indicates that shares are being traded at a price lower than the issue price, signaling weak demand and a potential discount to the listing price. For example, if the issue price is Rs 500 and the GMP is Rs -200, the listing price might be anticipated to be Rs 300.

To get a full list of the upcoming, current, and closed IPOs, check our Unicorn Signals App – IPO Scanners tool, and fetch the latest updates.

Disclaimer: Investing in the Equity market in India is subject to risks, i.e. the market keeps on fluctuating. This article is purely for educational purposes. The views expressed and data provided here are by Equitypandit’s team. Kindly do not completely depend on the information provided as the risk appetite differs from individual to individual and there are various other factors in the market to determine the factors to invest in the market.