The unofficial market wherein individuals buy or sell IPO shares and applications even before they are officially launched for trading on the stock exchange is known as the grey market. Being an unofficial over-the-counter market, it has no regulations surrounding it.
The transactions in the grey market take place in the form of cash on a personal basis. Grey market is not backed by any of the third-party firms like SEBI, Stock Exchange or Brokers. Trading in the grey market is usually taken up by a smaller set of people because there is no official platform or set of rules that define this type of trading.
Does the grey market constitute a part of the IPO market?
The IPO market and the grey market do not have any direct relationship. The IPO market is both official and organised in its conduct for raising funds in the market and functions as per the SEBI guidelines. On the other hand, the grey market does not have any guidelines circumferencing it.
The traders, however, offer shares and bid for the upcoming IPO in the grey market. These are more like the unofficial forwards on the shares and are not the actual shares of the IPO.
The trades are majorly carried out over the telephone due to being an unofficial market. The grey market traders start bidding on an IPO before the company lists them.
Various factors like retail appetite, the reputation of the promoters, institutional appetite, the possible extent of oversubscription, etc. are taken into account while bidding in the grey market. The prices are determined by demand and supply.
What does the grey market actually issue?
The grey market is viewed as an indicator of the performance of the stock once the company lists the shares. Investors and brokers give offers and bids at various prices for IPO stocks. The grey market largely runs on trust.
The retail investors, as stated above, view this market as an indicator of post-listing performance. On the other hand, the HNI investors view it as an indicator of the appetite for the stock which helps them to decide on how much to apply for when the IPO gets listed. The financiers are able to get an idea of whether financing the IPO would be a lucrative proposition or not.
What is the kostak price and regulations?
The everyday word used for the price of the application is Kostak. Kostak rate is the price at which the applications are sold in the IPO market. Higher demand means a higher Kostak price. It is important to remember that the price in the grey market can fluctuate wildly as there is an absence of SEBI regulations.
The grey market is not guaranteed and thus an investor runs a counterparty risk while buying and selling in the grey market. The regulator generally discourages retail investors from trading in the grey market owing to the risk. The grey market is open to default by other markets, which makes it more like a forward market.
The transactions in a grey market are forward transactions that are open to counterparty risks. It is advised to not take the grey market trades very seriously and the prices are subject to major manipulations.
The Grey Market Premium (GMP)
The premium that the investors are willing to pay over the issue price is termed as the Grey Market Premium (GMP). The price at which the shares are offered for sale before they are listed in the stock market is called the issue price.
GMP assists in measuring the interests of the investors in a particular IPO. It acts as a reflection of the performance of the IPO on the final day of listing. GMP of an IPO depends upon the demand and supply of the stock. How does this work? If the number of shares that have been offered in the IPO is greater than the subscription number of that IPO, then the GMP will be lower.
Suppose a company decides to offer a total of 1 lakh shares with the cut off price fixed at Rs. 250 after the bidding window closes. Now the subscriptions are a total of 1.5 lakh which is greater than the shares actually offered. Due to greater demand, the GMP is fixed at Rs. 100. It means that the investors in the grey market are willing to Rs. 350 (Issue price + GMP) for the company’s shares. This is an instance of positive GMP.
To understand negative GMP, let us consider a company offering 50,000 shares with a cut off price fixed at Rs. 120 after the bidding window closes. The subscriptions that are received are 45,000 which is lesser than the actual number of shares offered. Due to less demand, the GMP is fixed at negative ( - )Rs. 50. This means the investors will be paying Rs. 70 ( Issue price + GMP) for the share.
GMP is regarded as a signalling mechanism for being a fair indicator of the demand of the IPO. However, the grey market is not an organised and regulated market, due to which the GMP can be manipulated.