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Grey Market Premium. What Is It and How It Affects IPO Listings

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1. What is Grey Market Premium? How does it Affect IPO Price

The Initial Public Offering (IPO) space or the primary market is not as abuzz as last year. The reason is relatively straightforward, the underperformance of the stock markets. 
When the overall sentiment about the stock markets was upbeat, many companies submitted Draft Red Herring Prospects (DRHP) to the market regulator Securities Exchange Board of India (SEBI). But as soon as the market stopped performing well and the buoyancy subsided, many companies stopped their IPO listing plans. 

We have covered additional reasons for a sluggish IPO market here.
Grey Market – A company’s to-go-public plans are directly linked to the stock market performance. There is one more market that decides the fate of an IPO which is the Grey Market.

Understand DRHP This is a detailed bio-data of a company. It is a document the company that intends to list on the stock markets prepares. The paper has thorough information about a company’s shareholding pattern, management information, growth plans, business model, target audience, associated risks, and much more. Download a sample DRHP here.

What is Grey Market?

There are three types of markets – White, Black and Grey.

  • The White market is the stock market you trade or invest in, NSE and BSE. It’s regulated by SEBI.
  • The Black market is an unofficial and illegal marketplace where goods or stocks are traded outside government-approved channels or parties.
  • The Grey market is an unofficial playground where stocks are traded without an authority’s control, such as SEBI, but it is not illegal. Therefore, the deals carried out in this market are acceptable.

Stock market participants call it the ‘Parallel market’ or ‘over-the-counter’ market. They indulge in grey market trading primarily to buy shares of companies that will soon list or have stopped trading on the official stock market but are in demand.

Note: While not all grey market stocks are associated with public issues, some are also issued by start-ups or spin-off companies looking to test the waters before a public offer. The marketplace offers a playground for such companies to gauge their valuation.

Unlike the primary market, the Grey market also facilitates trading in IPO applications, meaning a buyer can sell the applications to a willing buyer. Since the Grey Market is not an established marketplace with governing rules and regulations, deals are done in person, over the phone, and among a trusted investor group. And these transactions are carried out in cash only.

As mentioned earlier, this marketplace is not regulated by SEBI or any other governing body. So, there are fewer legal options available to parties involved in case of fraud.

What Is Grey Market Premium (GMP)?

Grey Market exists because of the ‘premium’ price traders or investors are willing to pay for some stocks. So they call it Grey Market Premium or GMP. 

The higher price investors are willing to pay over and above the issue price of an IPO that they believe will list at a very high price. A stock in-demand receives a higher premium and vice versa.

Two examples below will help you understand how it works –

Company A with higher demand, receives positive GMP

Suppose the IPO price of Company A is Rs 500 and GMP offered by buyers to the same company is Rs 80. In this case, the premium is positive. Because of a positive premium, the buyers are ready to purchase the shares of Company A at Rs 580 (Rs 500 + Rs 80).

Company B, with lower demand, receives negative GMP

In the second scenario, the grey market premium offered for Company B is Rs -30 while the issue price is Rs 500. A negative GMP means the sellers are looking to sell the shares at a discount because the seller believes the stock will list below the issue price. So, the seller is willing to sell the shares of Company B for Rs 470 (Rs. 500 – Rs. 30).

What is Kostak Rate?

Although the terms GMP and Kostak rates are used interchangeably, the latter’s concept is slightly different.

The Kostak rate is the sum a buyer pays to purchase the “IPO applications“. There is a difference between allotted shares and IPO applications. When a seller sells share applications, it does not guarantee the allotment of shares to the buyer, but a seller can secure a profit.

A seller secures profit means that whether the buyer gets the allotment or not, they are obliged to pay the decided amount. For instance, if you make five applications for an IPO and sell the same at Rs.5000 per application, you will make an IPO profit of Rs 25000. However, the profit will be the same if you get the allotment in two applications.

On the other hand, if you (the application seller) sell the allotted shares and earn a profit, you must give the profit to the buyer who bought the IPO application.

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How does Grey Market Premium Affect IPO Price?

Many believe that the GMP often decides the price at which a company can get listed. For instance, if the GMP is positive, the stock will likely list at a higher price. Conversely, if the GMP is negative, the stock will likely debut at a lower price.

We researched the grey market premium of some recent popular IPOs and their listing prices to understand if the belief above will hold. The table below illustrates what we found.

CompanyIndustryIssue Price (Rs.)GMP (Rs.)Estimated listing price (Issue price + GMP)Listing price (Rs.)
Ather IndustriesChemical64255697704
Glenmark Life SciencesPharma72082802750
Vedant FashionsApparel866-12854935
Star HealthInsurance900-80820845

Although the actual listing prices are not precisely equal to the estimated costs, the assumptions were valid for 70% of companies. Despite low demand for Delhivery and Vedant Fashions on the grey market, the companies listed at prices higher than their issue. The table shows negative and positive GMPs affect the stock listing price.

Does this mean you must only check on the GMP Premium and forget the company’s due diligence? No.

Make sure you study the company thoroughly before you invest. But, of course, there is no harm in making a note of the GMP.

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I’m Vinay Mahindrakar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.

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