Grey Market Premium (GMP) IPO - What It Is, Meaning, & Full Form

We all know that shares are bought and legally traded in the two markets: Primary and Secondary markets. Both of these are controlled and regulated by the Securities Exchange Board of India (SEBI). Shares of the companies are launched for the first time to be subscribed by potential investors in the Primary market. Then, these shares are listed on the stock exchange, i.e. secondary market, to be freely traded. Hence, SEBI plays an essential role in the functioning of these two markets. 

But do you know that there is another market that is informal and works based on trust? Moreover, it isn't controlled by the SEBI. 

In this blog, we will learn about another market we mentioned above. 

What is Grey Market? 

The grey market is an informal, closed and unofficial(kind of) market with no general rules. Grey Market IPO works based on trust. In short, it is not regulated by SEBI.

It can be said that shares in the grey market are not traded formally. As it is an unofficial market, it is not regulated by a formal institution. The transactions are done privately. Meaning investors have to assume all the risks associated with trading in such a market. Usually, very few people are involved in this type of trading as it is informal, and no third party regulates it. Trading is done with the assistance of unregistered dealers. GMP IPO/GMP is an important concept you should know if you are interested in IPOs. Let's learn about the grey market premium.

What is an IPO Grey Market Premium?

GMP IPO refers to the premium at which shares may get traded in the IPO grey market. We can say that it relates to the stocks traded outside the primary or secondary market when a company launches its IPO.

Let's have a better idea about the GMP of IPO through an example. Suppose a company, X Ltd., came up with its IPO for Rs 200. And the grey market premium happens to be Rs 10. It is assumed that when the IPO period gets over, and the shares get listed on the stock exchange, they may be listed at Rs 210. However, it may not work like this in many cases.

How does a Grey Market work?

Two ways through which you may earn income in the grey market are: 

• Before the shares of a company get listed on the stock exchange, you can trade them in the grey market 
• You may earn by selling your IPO application 

Let's discuss both these ways individually. 

Types of trading in the grey market

Buying/Selling IPO shares in the grey market before they get listed on the stock exchange 

• You apply for shares offered in the IPO of the company. You take certain risks while applying for it. The risk is that you may not get any shares, or the shares you get may get listed at less than the issue price. You are known as a seller.
• Now let's say your few friends think that the value of shares surpasses their issue price. Now, before the allocation of IPO shares, your friends will start piling up these shares. In this case, your friends may be known as buyers.
• With the assistance of the dealers in the grey market, your friends will place their orders for IPO shares. They may offer a certain premium amount for the same.
• Next, the dealers in the grey market will contact you. They may ask you to sell your shares for a specific premium.
• Let's say you are not ready to bear the risk associated with an IPO listing. You are tempted by the premium offered to you. Hence, you decide to sell your shares to the dealer. You book your gains. But the thing is, you will have to book the deal with the seller at a specific price.
• Now the dealer gets the information from you. He will inform your friends about the purchase. He will inform them that he has bought 'n' number of shares from you.
• Now, the allotment happens. It may be possible that you do or do not get any shares at all.
• The dealers of the grey market will contact you if you receive the shares during the allotment process.
• You will be asked to sell your shares at a specific price. Or you may be asked to transmit your shares to somebody's Demat account.
• If you sell your shares, the settlement may be based on two factors. They are 1) The profit or loss you bear 2) The GMP at which you and your friends transact
• But let's say you don't receive any shares during allotment. Then no settlement may be done. That's how shares are traded in the IPO grey market.

Buying and selling IPO applications in the Grey market

• Just like the shares of IPO get traded, trading of Initial offering's applications comprises both buyer and seller, i.e. you and your friends. 
• Your friends will decide the application's price based on various market conditions and predictions.
• Your friends may contact you and tell you that they will buy your Offerings application for a specific amount or premium. 
• If you wish to be on the safer side, you may sell your application to your friends via a grey market dealer at a premium.
• Here, you do not have to stress about whether shares will be allocated to you in an IPO. Even if you don't receive shares during the allotment process, you will get the GMP from your friend because you have already sold your application to them.
• You will send an application form to the grey market dealer. The dealer will inform your friend that he has bought the application from you at a specific premium. 
• It is clear that you may or may not get shares during allotment or allocation.
• Suppose you get shares in the allocation process. You'll have two options. You may be asked to transmit your shares to somebody's Demat account or trade shares at a specific premium. 
• If shares are traded, the settlement is computed based on the gains or losses.
• But if you didn't receive shares, the deal can not be finalised and automatically gets over. 
• But you will still receive the premium at which you traded your application.

That's how a grey market works.

What is the Kostak rate in an IPO?

Kostak rate is the premium or rate at which trading of Initial Offering's applications is done. Or kostak rates are the gains made by the applicants when they sell their applications even before the allotment of shares happens. 

You can indulge in such an activity if you wish to escape the risk associated with the allotment of shares. Or the risk attached to listing gains. 

Let's understand the Kosak rate IPO better through an example. Suppose you do not wish to buy the shares offered in the initial offering. You have a Demat account. Then, you can sell these shares/applications in the grey market. And let's say B is interested in buying your application. So he will pay you a specific amount, and B will subscribe to your application on your behalf. Here, the gains you enjoyed in the process are the Kosak rate IPO.

Mr B may or may not get any shares, but you will enjoy the gains anyway. 

How is GMP calculated for an IPO?

The process of GMP calculation isn't complicated. Let's say the price for XYZ's IPO is Rs 900 per share. The GMP for the same is Rs 100. Then the organisation's shares are expected to get listed for Rs 1000. The GMP's value varies daily depending upon the demand for shares in the market.

Hence, we can calculate the value of a share's GMP as:

GMPR = Grey Market Premium * Number of shares

Final words

In a nutshell, the grey market premium helps ascertain an IPO's performance post-listing. Though it only gives an idea and does not guarantee accuracy. However, it would help if you considered that activities here are prone to very high levels of risk. It would help if you indulged in such activities only after proper research and analysis. 

Frequently Asked Questions (FAQs)

Q.How to buy shares in the grey market?

If you wish to buy shares in the grey market, you have to look for unregistered/local dealers who can help you find sellers/buyers.

Q. How to buy an IPO in the grey market?

Dealers can help you finalize deals and buy shares to buy IPO in grey market as this market is out of the regulations of the SEBI.

Q. What is the full form of GMP?

The full form of GMP is Grey Market Premium.

Q. What is the rate gain in IPO GMP?

The rate gain in IPO GMP is the difference between the price at which the shares were bought in the grey market and the listing price. 

Q. How to buy and sell stocks in the grey market?

To buy and sell stocks in the grey market, look for dealers who can help you trade here, as no official individuals or businesses are involved in this. Moreover, these activities are usually performed in selected cities only.

Q. How accurate is GMP IPO?

The answer to "how accurate is GMP IPO" is "not very reliable". Though it may be correct in most cases, it does not guarantee accuracy.

Q. Is the grey market negative for the stock market?

Grey market is illegal. Traders support it because it allows them to purchase shares that haven't been issued on exchanges and profit from it.