What is Grey Market? Types and How are IPO Shares Traded?

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In addition to analyst recommendations and a draft red herring prospectus, investors now consider grey market premiums or GMPs before subscribing to an IPO. Over the years, grey market premium has become a crucial criterion for determining whether an unlisted stock can achieve the anticipated listing profits.

Here is a straightforward explanation of what the grey market premium is and how it is determined.

What is the Grey Market in India?

Legally, shares are traded on the primary and secondary markets on a stock exchange such as NSE & BSE. In the primary market, new shares are produced and sold to the general public. Initial public offering is a primary market example. Following their listing, shares are traded on the secondary market. The Securities and Exchange Board of India regulates the transactions that occur on the primary and secondary markets. Prior to being listed, shares are however exchanged informally on the grey market. The grey market for stocks is a closed, informal market that functions based on trust rather than rules. The grey market is not regulated by SEBI or any other regulatory entity, and investors must assume all risks associated with operating on the grey markets. On the grey markets, transactions are frequently conducted via small slips of paper and unregistered sellers.

Grey markets have operated in India as a parallel stock market for a long time, and its legitimacy is validated by dealers and investors. Grey markets are mainly based on supply and demand, with traders and retail investors purchasing shares before they are listed. If a person wishes to exit the IPO for any reason, the grey markets provides an option. Individuals may also purchase IPO shares after the deadline has passed. Prior to getting listed, a company might trade its stocks and applications on the grey markets. These markets also provide underwriters with the chance to comprehend the company’s future after its listing.

Grey Market In Stock

A grey market of stock is one in which traders offer and bid on the company’s shares unofficially. If a company offers its stock to traders before the shares are released in an Initial Public Offering (IPO), the stock is referred to as grey markets stock. The grey markets stock is often managed by a small group of individuals, and all transactions are based on mutual confidence and trust. In India, the trading of equities on the grey markets is legal but unofficial.

Grey Market Premium

Grey market premium refers to the price at which Initial Public Offering (IPO) shares are traded on the grey market. The live grey market premium indicates how the IPO will perform on the day of listing. When a company issues its initial public offering (IPO), the shares is bought and sold outside of the stock market. Trading initial public offering (IPO) shares on the grey market carries a high degree of financial risk, as these shares are often distributed at prices below the IPO price. When purchasing IPO shares on the grey market, buyers must make orders at a certain premium. The dealer reaches out to the sellers and requests that they sell the IPO shares at the grey market premium. Those who do not wish to assume the risk of stock market listing sell their IPO shares at a predetermined price on the grey market.

Prior to entering the grey market, it is important to consider a number of concerns, despite the fact that investors, dealers, and businesses have utilized the grey market extensively and that there are a number of grey marketplaces with substantial trading activity. These concerns include the fact that trading on the grey market can damage the reputation of publicly traded companies and can also be dangerous at times.

Here’s an example to illustrate:

A company announces its initial public offering (IPO) and sets the price per share at 100. The grey market premium per share is 20. On the unofficial market, it is anticipated that the stock will be listed at a price of approximately 120. Investors who believe a public offering to be underpriced might purchase the shares on unofficial markets at the predetermined pricing, while sellers can realize gains by selling over the issue price. GMP, like stock prices, can fluctuate daily depending on a variety of reasons.

How is Grey Market Premium Determined?

The grey market premium is determined by stock demand, valuation, supply for a company’s shares, market sentiment, valuations of the company, its financial data, and future prospects. If there is a large demand for a stock or market sentiment indicates that the valuation is reasonable or affordable, the grey market premium will be on the high side. This means that the stock may be listed at a price higher than its issue price.

In contrast, the grey market premium might be low, nil, or negative if demand is minimal or the market perception is that the valuation is high. If the GMP is negative, it indicates that the stock could be listed below its initial public offering price. The market sentiment also influences grey market premiums; a bullish market has a favourable effect on premiums, while a bearish market might reduce them.

Given that the buyers and sellers of unlisted space remain unknown, it is difficult to attribute the grey market premium to a single person or factor. It is dependent on numerous circumstances and parties.

Employees who sell their vested employee stock ownership plan (ESOP) shares and private clients who were granted shares by the company before the IPO are examples of those who sell shares on unlisted markets.

However, it’s important to note that grey market premiums fluctuate and are indicative only. They are not conclusive evidence of how the stock will perform on the stock market.

What is IPO Kostak Rate?

Kostak Rate is the profit made by a seller when he sells his IPO application on the grey market. This is completed prior to the allocation of shares.

A company, for instance, has established an issue price of Rs 15,000 per lot. The kostak rate on the grey market is Rs 1,000. This means that purchasers are purchasing the full application on the grey market for Rs 16,000 (Rs 15,000 plus Rs 1,000 kostak rate) per lot.

In this kostak transaction, a seller’s profit is Rs 1,000 regardless of whether he receives shares. If shares are issued, he retains Rs 16,000 and gives the remainder to the buyer if a profit is made. If shares are sold for less than Rs 16,000, the buyer is responsible for the difference.

However, even if the purchaser approaches 50 individuals with kostak rates, this does not guarantee allocation to each individual. Therefore, to avoid such a risk, sauda is applied.

What is Subject to Sauda?

Subject to Sauda is a type of IPO Grey Market transaction in India:

Unofficially, an investor may sell an IPO Application to a buyer at a predetermined price (Kostak Rate) prior to the listing of IPO Shares on the public market. In the case of a ‘Subject to Sauda’ contract, the buyer and seller agree that the sale of an IPO application on the grey market is only legal if the seller receives the allotment. If the seller does not receive any shares during an IPO, the transaction is cancelled.

For instance, business XYZ is launching an initial public offering for Rs 100 per share. IPO Shares will likely be listed within 15 days. A seller may sell his Rs 2 lakh Retail IPO allocation for Rs 5,000 “Subject to Sauda.”

If the seller is allotted, he would receive Rs 5,000.
If the seller does not receive an allocation, he will receive nothing.

Types of Trading In Grey Market

In a grey market for IPOs, there are two forms of trading:

Before their listing on stock exchanges, allocated IPO shares may be traded (sold or purchased).
Trading (buying and selling) IPO applications at a specified rate (premium)

How are IPO Shares Traded in the Grey Market?

Investors who apply for an impending IPO are concerned about the performance of shares upon listing, therefore they attempt to book profits by selling their shares on the grey markets. They are the sellers in this exchange.

Investors who believe the shares are more valuable and may be listed at a premium attempt to acquire them from the grey markets. They are the buyer in this exchange.

Buyers contact grey market dealers in order to purchase shares at a specified grey market premium (GMP).

Dealers in the grey markets approach sellers who have applied to sell shares.

If the GMP is acceptable to the seller, the transaction is completed. Later, the dealer gets the application information from the seller and notifies the buyer of the transaction.

The seller could or might not receive the share allocation.

If the shares are allotted, the seller must transfer them to the buyer’s Demat account or sell them on the open market to cover the difference.

If shares are not allocated to the seller, the transaction is terminated without payment.

How are IPO Applications Traded in the Market?

Following are the steps for dealing with grey markets IPO applications:

Buyers evaluate the price of an application based on many assumptions and market factors. They offer to purchase an IPO Application from the seller at a premium.

To protect their investments, sellers may sell their application to the buyer via a grey market broker at a premium.

In an IPO, the seller is not responsible for the distribution of shares. Even without an allotment, they still receive the grey markets premium. Since the seller has already sold the application for an IPO.

The seller sends the application to the dealer. Next, the dealer notifies the purchaser that he acquired an IPO application from grey markets vendors for a set premium.

The seller may or may not receive an allotment of shares.

Suppose the seller is allocated IPO shares. In such a scenario, any seller may receive a phone call from the dealer telling them to transfer assigned shares to a Demat account or sell them at a predetermined price.

Profit or loss determines the settlement in the event that shares are sold.

If the seller receives no allocation, the transaction is cancelled. However, the seller continues to receive the application’s premium, known as the Kostak rate.

Who Should You Contact to Trade in the Grey Market?

As the IPO Grey Markets is an over-the-counter market, there are no official individuals or businesses to contact. If you wish to purchase or sell IPO equities on the Grey Markets, you must locate a local dealer who can identify buyers or sellers on your behalf.

Conclusion

Grey markets is mostly utilized by investors as a predictor of the near-future performance of listed stocks. However, you should keep in mind that the grey markets is an unofficial channel and that regulated members such as SEBI, brokers, and investing platforms are not associated, therefore it carries its own set of concerns. However, it may enable buyers and sellers, as well as organizations filing an IPO, to measure market sentiment and obtain some price discovery benefits.

FAQs

How does IPO application trade in the grey market?

On the grey markets, IPO applications are exchanged in the same manner as IPO shares. The major distinction is that the buyer must pay a premium to the seller even if the seller does not receive any shares through the application.

Why do people trade in the grey market?

Grey markets give investors and dealers the ability to buy or sell securities before they are traded on stock exchanges. It also provides a sense of the prospective gains or losses from an IPO by measuring sentiment through grey markets transactions.

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