Grey Market; sounds weird, right? Grey or parallel in the share market is the place where shares or stocks of unlisted or companies that are about to list in official trading channels are traded. These markets are unofficial places where investors execute grey trading. In this article, we will discuss one of its crucial terms, the grey market premium that also impacts the authorized stock market – BSE and NSE in the case of India.
What is Grey Market Premium?
Grey market is an unofficial market where a small group of people buys or sells IPO shares before they launch officially in the stock market (NSE or BSE). There are no regulations to run such a market to maintain a proper balance between sellers and buyers of respective shares.
Additionally, most trading happens in cash on a personal basis; there is no involvement of brokers or regulators like SEBI and the stock exchange. The trade happens between traders or investors who are backed by themselves personally. In this market, GMP and Kostak are two major terms explained below.
GMP is the short form of Grey Market Premium, the premium value at which the IPO shares in grey markets are traded among traders and investors. Grey market IPOs are the shares involved in trading before their listing on the official stock exchange. It gives hints about the performance of IPO shares on listing day.
Example of GMP in Share Market
Let’s support ABC Ltd is about to issue 1,00,000 IPO shares through the book-building process, where the issue price is Rs 1,000 per share. Because of its brand value and the latest market trend, it gets 1,20,000 subscriptions, and investors are willing to pay Rs 100 GMP value to subscribe to this share. It means the investors are ready to buy this IPO share from ABC Ltd at Rs 1,100 per share (Rs 1,000+ GMP of Rs 100).
In this case, investors were willing to pay a higher amount for the IPO share. However, there can also be a reverse condition, resulting in a negative GMP value. Let us understand this condition with the below-mentioned example.
PQR Ltd constantly witnessed slow growth, and due to rapid enhancement in technology, it decided to launch its IPO share in the market. It decided to issue 1,00,000 shares at Rs 1,000 each. Investors are not sure if they will make a profit with this share. Therefore, they will pay GMP or Rs (-100). It means the IPO shares of PQR Ltd are trading in the grey market at Rs 900 (Rs 1,000 – GMP of Rs -100).
Understanding Kostak Rate
Kostak rate represents the amount the investor is willing to pay for IPO shares that are about to launch in the official market. The investors can buy or sell their full IPO applications in the grey market at the kostak rate to make a fixed percentage of profit. The amount of kostak rate fluctuates based on the allotment of the selected share.
How is GMP in the Stock Market Calculated?
The GMP is calculated based on the issuing IPO share’s demand and valuation. If there is a higher demand for the upcoming IPO share or if market sentiments reflect that the share is priced fairly or it will see an increase in its price, in that case, the grey market premium will be higher. However, if market sentiment about upcoming IPO shares is that the share price will drop on a listing date, then the grey market premium for the share will be less than the issue price.
The bullish nature of the market also has an impact on GMP but in a positive manner. Whereas the bearish market reversal impacts the GMP value. Once there is some fixed idea about the price of a share in the grey market, you can calculate the premium amount of the IPO using the below-mentioned formula.
GMPR = Grey Market Premium x Quantity of IPO Shares
Understanding the Basics of GMP
The Grey market mainly gets the attention of investors when a bank undervalues the IPO share which is about to launch, or the IPO share has already fully subscribed. Investment banks’ suggested prices are much lower than the grey market, which can even result in a loss if trusted blindly.
However, if you think a certain company’s IPO share is undervalued, the grey market can be a great option to avail yourself of such a great trading opportunity to profit by buying these shares at a low price. The GMP can be as high as 40% of the issuing price of the share. However, NSE has developed the price band feature to control this measure. Many stock brokers have discovered a way to issue IPO through Demat, providing adequate GMP.
The Grey market is unofficial and not regulated by a third party. Also, non-broker dealers facilitate the traders for IPO shares. Due to this feature, it’s a totally illegal practice in many countries; however, it’s also legal in some countries. In India and America, the grey market is often called the direct market, and trade that happens through it is called Dabba trading.
How Can One Trade in the Grey Market?
Grey market trading is participating in trading activities in the unofficial stock market. To perform this trade, you must contact the mediator in a physical mode in your nearest location. The mediators are present in most cities nationwide to facilitate dabba, parallel, or grey market trading.
Remember, trading in the grey market can be risky as it’s not regulated or backed by third parties like SEBI. Also, you would be required to pay for subscribed shares in cash mode and be there physically before the buyer, seller, or mediator.
So, GMP is the grey market premium at which the investors are willing to buy or sell the IPO shares in the unofficial stock market. As there is no involvement of stock market regulators like SEBI and SEBI registered stock brokers, it’s safer to stay away from this market, especially if you are a complete beginner in the stock market.
However, if you think you can make informed trading decisions to make some profit by buying IPO shares at low and selling at high. Hopefully, you have understood the meaning of grey market premium and kostak rate, commonly used in this market.