IPO - Grey Market Premium

By Research Desk
about 6 years ago

GREY MARKET – It’s a very black and dark place

For those of living in this colorful world, black and white might be two ends of the same paradigm, with black conveying all that is wrong and white standing for all that is pure and correct. But to live, just a pure black and white life is impossible, which is why we all, at some point of time or the other, adapt a middle path – the grey. That’s the only way to survive.

But in the stock market, there are more colours – black, white, green and red. There is also “grey” but it has a very different connotation. A grey market represents an “unofficial market”; it stands for something is valued based on demand/supply outside the structured framework.  This “grey” is not required for survival but those punters, who are street smart and seek to make a quick buck, grey is their most preferred colour.

10 Surprising Facts About Grey Market Premium (GMP)

  1. The unofficial market for the primary or IPO market
  2. Grey market premium not just on IPO shares before they are listed but also on the IPO application
    • Kostak rate - at which one is willing to sell the IPO application (retail category only) in the grey market
  3. This pre-IPO market is unofficial thus there are no rules and regulations to control this grey market
  4. All transactions in an IPO grey market are done in cash
  5. ‘Trust’ is basis of all grey market transactions – small slips of paper are the ‘contracts’
  6. Grey market is open to default by the other party – more like a forward market
  7. There is no ‘official’ dealer – all buying and selling thro’ word-of-mouth only
  8. Direct proportion - Higher the premium for an IPO in the grey market = higher possibility of it getting listed at a bumper price on the bourses
  9. Grey market - major instrument for price manipulation
  10. While grey market premium is generally available for companies which have announced price bands, activity can start much earlier too

What Does Grey Market Premium Mean?

For IPO bound companies, grey refers to the “grey market premium.” This is an unofficial market for the primary or IPO market. Here, the shares on offer in the IPO are purchased and sold before it gets listed on the stock exchange. This is more like word-of-mouth market, where price is decided by certain parties. And because this pre IPO market is unofficial, it automatically means that there are no rules and regulations to control this grey market. And when the market is unofficial, naturally, black will be the dominant colour, meaning all transactions are done in cash and on a personal basis. If you get duped, tough luck as the grey market has no backing either by SEBI or stock exchanges or any official authority. What you do in the grey market is your risk alone; you alone are responsible. Despite sounding so ominous and SEBI warning against trading, the grey market thrives.

This grey market is purely operating on trust; there is no written contract or application. The higher the premium for an IPO in the grey market much higher is the possibility of it getting listed at a bumper price on the bourses. Thus in many ways we can infer that the grey market premium is a direct pointer to the post-listing performance of the stock.

When we talk about grey market premium, we are talking not just about premium on IPO shares before they are listed but also on the IPO application.

How do Grey Markets Work?

First the modus operandi of how grey market works for IPO shares. Suppose Mr.A applies for an IPO (in the retail category of upto Rs. 2 lakh application). Mr.A is aware that he might not get any shares allotted or the stock might get listed at a discount. Yet, he decides to take a risk.

On the other hand, there is Mr.B who is sure about the IPO company’s prospects and wants to get assured allotment without going through the IPO. Mr.B contacts a grey market dealer through his unofficial channels and the agent assures Mr.B that he will get him the shares allotted. The agent acts as the mediator and negotiates a perceived premium price for the IPO share. He tells Mr.A that there is a buyer ready if he is willing to sell on receiving allotment. Mr.A is assured of a premium of Rs.50 over the IPO price, irrespective of its listing price. Mr.A agrees and the agent notes down his IPO application details, which he shares with Mr.B. On the D-day, when Mr.A gets shares allotted, the agent advices him to sell the shares and pays him the premium of Rs. 50 per share over the IPO price, while Mr.B buys them for the agreed price (IPO price + Rs. 50). If listing price is above this price, Mr.B makes a profit and vice-versa.

Understanding Kostak: Definition & What it Means

And now we turn to the grey market for IPO applications. In market parlance this is known as kostak – the price one is willing to pay for the IPO application. The kostak rate is the pre-determined price in the grey market – that’s the rate at which one is willing to sell the IPO application in the grey market. Here too higher the perception and frenzy generated for the IPO, higher is the kostak and the grey market premium price for the shares.

To get a better perspective of kostak, continuing with the above example, suppose there is a bid to buy the IPO application from Mr.A by a grey market agent for Mr.B. Let’s assume that the upper end of the IPO price band is at Rs.225 with lot minimum lot size at 65. The quoted kostak price is Rs.700 while grey market premium (GMP) is at Rs.40. Now if Mr.A sold his bid to Mr.B, Mr.B would have to immediately shell out Rs.700 to Mr.A.

  • Now, if the share gets listed at Rs.300, which is Rs.75 more than the IPO price, net gain is Rs.4,875, assuming allotment of 65 shares. But then the kostak price was fixed at Rs.700. This will now pinch Mr.A as he will keep only Rs.700 and give Rs.4175 to Mr.B.
  • On the other hand, if the stock had got listed much below the IPO price or had not got an allotment at all, Mr.A would have been the bigger gainer.

In recent times, we saw huge kostak happening for the IPO of D-Mart or Avenue Supermarket. The kostak rate was at Rs.2600 and HNIs were the biggest bidders with many borrowing money to invest in the IPO. Ultimately as we all know, D-Mart got listed at Rs.604.40 on the BSE as against the IPO price of Rs.299 and today it is quoted well over Rs.1590 levels, with its 52-week high at Rs.1682. D-Mart was an exceptional case and this happens only once or twice in a lifetime.

How Do I Contact A Grey Market Dealer?

There is no “official” office or registered broker who does grey market deals.  And unlike Dalal Street, BSE and NSE, there is no specific place where grey market deals are done. It’s all unofficial and runs purely on trust.

The network of people who do these clandestine deals run purely on word-of-mouth and because it is unofficial, unless you have a ‘contact’ and are able to establish trust, these grey market dealers are wary of people whom they do not know or are not ‘introduced’ to. Thus if you really want to get into a grey market deal, you will really need to scout around and talk to a few people in the market to eventually get ‘introduced’ to a dealer.

The grey market trading is active mainly in cities of Gujarat where it enjoys a notorious reputation. Some dealers can be found in Jaipur, Mumbai, Delhi, Kolkata, Indore too.

But our sincere advice – please do not go looking around for grey market dealers; the chances of you burning a hole through your pockets are more certain than actually earning any profit. It is always the small investor who gets stuck in such deals where HNIs use all power – money and muscle to manipulate prices to their benefit first.

Grey market manipulations:

Grey market is notorious being a major instrument for price manipulation. There have been so many instances of stocks getting listed at a bumper price on the day or listing, only to fall like ten pins on the next day.

So how does this happen, especially when they had bumper subscriptions and listings at unbelievable premiums, way ahead of their fundamentals? This is nothing but pure price manipulation, catapulting gullible investors into losses. Usually, we associate price manipulation in stocks which are very weak on fundamentals but strangely, the trend being seen is manipulation in stock prices which are strong. Sometimes stocks sadly become victims of manipulation by a handful of operators, making one wonder about their prowess.  

Grey Market Operators

Grey market trades are largely done by High Networth Individuals (HNIs), who make large applications in the HNI category of IPO.

The so called operator mops up the share in grey market. After mopping up the shares in the grey market, on listing day, the said operator buys the big quantity from the open market as well, and virtually buys entire allotment of HNI category and part of Retail category as many of them are seen applying for listing gains only. All grey market trades are compulsorily executed on listing day on NSE or BSE, with difference in rates being settled in cash.

Last year, one grey market operator is learnt to have mopped up about 20% shares of the IPO portion in one week, at a very low cost. After jacking up the prices he sold half the shares at nearly 40% profit in 2 weeks! The game is not yet over as the operator was still holding about half the quantity of shares.

So who buys the shares being sold by the operator? Of course the gullible investor is lured by the listing price as he feels he had lost out and now wants to sink his teeth into this juicy pie. The “luring” process is aided by so called “technical experts” who led these gullible investors like lambs to the abattoir by putting out buy calls on these stocks.

On the face of it, there is neither anything illegal nor has there been any violation or harm in buying or selling large chunk of shares of any company. But if you look closer and unravel this messy knot, it is as clear as daylight that the very origin of this entire manipulation is the Grey market. Apart from the loss of money, what is extremely worrisome is that this will lead to a loss of confidence in the market, which after years has just about returned. This entire process of price manipulation makes the stock market look like a casino.

Warning on Grey Market & Its Operations

Thus our fervent appeal to all investor is that they should not make the grey market premium an indicator of the success of failure of an IPO, based on which they make their investment decisions. If a company is fundamentally very strong, backed by an equally strong promoter and priced reasonably, it is sure to see an over subscription. So pay more attention to the project, the business model, the objective of the IPO. Kostak and grey market premium is just a reflection of these factors but not all the time. Hence a higher grey market premium is not a guarantee for a listing gain or long term gain.

Our straight advice – stay away from the grey market; better to have losses than anxious, sleepless nights and the feeling that you were duped by some powerful manipulators.


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