You are already familiar with what is IPO. If you have been investing in the IPOs for quite some time, then it is highly unlikely that you have missed out a reference to the grey market. You must have heard of your broker telling you that the IPO is quoting at a grey market premium or a grey market discount. What is the grey market and what do you understand by this grey market? Here are some FAQs on the IPO grey market:
The grey market is an unofficial market while the IPO market is an official and recognized medium of raising funds in the market within SEBI guidelines. The IPO market and the IPO grey market do not have any official relationship whatsoever. You know what is IPO in the share market, but it is also important to know about the grey market in IPOs.
Let us clarify here that the grey market is an unofficial market where interested traders can bid and offer shares of a forthcoming IPO. These are not actual shares of the IPO but unofficial forwards on the shares.
Since it is an unofficial market, the trades are largely carried out over the telephone. Before a company lists, these grey market traders will start bidding on the IPO shares based on factors like the institutional appetite, retail appetite, extent of oversubscription, reputation of the promoters, etc. Grey market prices are determined by demand and supply.
The grey market is a market that largely runs on trust. It is a small set of people who give bids and offers for the IPO stock at various prices. Many investors and brokers look at the grey market as a rough indicator of the post-listing performance of the stock. There are unofficial contracts represented by slips of paper, and the transactions are entirely based on mutual trust.
For retail investors, the grey market price is indicative of the post listing performance. For HNI investors, it gives them an indication of the appetite for the stock and helps them decide how much to apply for in the IPO. For IPO financiers, it gives them an idea of whether financing the IPO can be a lucrative business proposition or not.
Grey market premium is easy to understand. The IPO grey market premium represents what the punters are willing to pay above the discovered price of the IPO. To understand what is GMP in IPO markets, one must understand how unofficial premiums are set for IPOs.
Kostak is the colloquial word for price of application. To understand what is Kostak in IPO, you need to understand what Kostak rates mean. It is the price at which you can actually sell your application in the IPO grey market, and higher demand means a higher IPO Kostak price.
As mentioned earlier, the grey market is an unofficial market and operates outside the ambit of SEBI regulation. Any trade or bids done in the grey market does not have the authorisation or approval of the regulator or any of the stock exchanges. Remember, prices fluctuate wildly in the grey market as there are no circuit filters.
Yes, you do run a counterparty risk when you buy and sell shares in the grey market. Since this is not a market regulated by SEBI, the regulator normally dissuades retail investors from participating in these markets. Unlike exchange-traded transactions, where the clearing corporation is the counterparty, the grey market is open by default to the other party. To that extent, it is more like a forward market.
Let us say you applied in an IPO for 800 shares and got allotted 400 shares. In the grey market, the stock is quoting at a premium of 45%. Hypothetically, you can sell these shares in the grey market and lock in the price. If the stock lists at 20% premium, then you tend to benefit. But, if the stock lists at a 100% premium, then you tend to lose out. We would like to add that this is an unregulated market and hence it is vulnerable to counterparty risk.
As stated earlier, the grey market is a closed market which operates outside the purviews of SEBI regulations. Hence, all transactions are in the form of forward transactions and are open to counterparty risk. At best, you can look at grey markets as an indicator of the listing price. Again, do not take these too seriously as grey market prices are also subject to manipulation.