Gafar Market and Nehru Place in Delhi or Heera Panna Market in Mumbai have become household names across India. These are one of the most popular grey markets for electronics and software in the country. But grey markets are not limited to electronics and software, even stocks have grey markets. Grey market rates for unlisted companies or companies about to be listed are often sought by investors to get an idea of the script’s future performance.
What is the grey market?
Legally shares are traded in the primary and secondary markets, which is facilitated by the stock exchanges. New shares are created and sold to the public in the primary market. An initial public offering is an example of a primary market. After getting listed, the shares are traded in the secondary market. The trades that take place in the primary and the secondary markets are facilitated by stock exchanges and regulated by the Securities and Exchange Board of India. However, before being listed shares are informally traded in the grey market. The grey market for shares doesn’t is a closed, informal market that operates on trust rather than rules and regulations. The grey market is not regulated by SEBI or any other legal authority and any risks arising out of operating in the grey market has to be borne by the investor. The trades in the grey market are often carried through small chits of paper and unofficial dealers.
How does it work?
The grey market runs outside the authority of the stock exchanges or the SEBI. Let us try to understand how the grey market operates. Suppose the IPO of a company opens and Mr X applies for a certain number of lots in the retail category. At the application stage, Mr X has no idea about the chances of allocation. Another investor Mr Y is also interested in the shares of the company. Mr Y wants surety in the allotment and hence, doesn’t want to proceed through the official channels. My Y gets in touch with a grey market dealer to buy a certain number of lots in the IPO. The dealer contacts Mr X and concludes a deal with him. The dealer offers Rs 10 extra per share over the IPO price to Mr X.
Now, if Mr X agrees, he will have to sell all the shares to Mr Y at the IPO price + Rs 10, if he is allotted shares in the IPO. In the deal, Mr X will get a guaranteed profit of Rs 10 per share, irrespective of the listing price and Mr Y will get guaranteed ownership of the shares if Mr X is allotted the shares. If Mr X gets allotment, the dealer advises him to sell the shares to Mr Y at the agreed price. On the listing day, if the shares lists at a premium of over Rs 10 per share, Mr Y earns a profit and vice-versa.
What is GMP?
The grey market determines the share price of an IPO-bound company depending on the subscription data and investor sentiment. If the demand for shares is too high and the supply limited, the share quotes a premium over the allotment price. Buyers offer an additional amount over the IPO price to get the shares before listing. In the previous example, the additional Rs 10 per share offered to Mr X over the IPO price is the GMP. Shares of every company don’t command a premium in the grey market. If the response to the IPO is tepid, the shares may change hands at a discount in the grey market. Investors take cues from the GMP for the listing price and to gauge the overall response to an IPO. However, GMPs may not always be an accurate indicator as the grey market is susceptible to manipulation.
What is Kostak Rate?
The grey market is not limited to the trade of shares before listing. You can also buy or sell the application in the grey market. The GMP becomes applicable only when shares are unofficially traded. But what if an investor wants to bet on the application itself? The rate at which full IPO applications are sold in the grey market is known as Kostak rate. The Kostak rate is dependent on the allotment of the shares.
As the grey market is outside the ambit of legal authorities, it is safe to stay away from it. However, the rates quoted in the grey market can be an effective indicator of the performance of an IPO. The GMP or the Kostak rate should be taken into consideration only to get an idea of a scrip’s future performance.