When an IPO is issued, it is launched in the primary market and once the IPO is listed, it is traded in the secondary market. Both are SEBI-regulated markets where trading is facilitated by the stock exchanges. However, before listing, the company’s shares are still bought and sold on an unofficial and unregulated market called the grey market. The price at which an IPO is traded on the grey market is known as the IPO GMP or grey market premium.
The GMP is an important factor to consider before applying for an IPO as it indicates investor sentiment, the demand for an IPO in the market, and the premium or discount that can be expected when the IPO is listed.
If you are looking to invest in an IPO, this article provides a complete guide to the GMP of the IPO, how does IPO GMP works, how it is calculated and how the GMP of the IPO affects the share listing.
What is Grey Market?
The grey market is an informal, unofficial and unregulated market based on trust rather than established rules and regulations. Unregistered traders facilitate all trading activities (buying and selling) in such a market. The market regulator SEBI does not regulate the grey market, so all risks are ultimately borne by the investor.
The amount of premium a trader or investor is willing to pay over the IPO issue price in the grey market is called the IPO Grey Market Premium (GMP). If there is strong demand for a company’s IPO, that company’s shares will trade on the grey market at a high premium while an IPO with poor sentiment or tepid demand may trade at a discount.
IPO investors look for the IPO GMP to estimate the expected IPO listing price. It should be noted that the GMP is not a 100% accurate predictor of listing price of IPO shares.
Track all upcoming and open mainboard and SME IPOs GMP on our IPO GMP Dashboard.
How does IPO GMP work?
In general, GMP is an indicator of whether an IPO will list at a premium or a discount on the exchange. A positive GMP for the IPO suggests a profitable listing (listing price > issue price), while a negative GMP predicts that shares of the IPO will be listed at a loss (issue price > listing price). An IPO with strong demand, where the number of IPO subscribers exceeds the number of shares offered, the GMP will be high or vice-versa.
To understand this, let's take an example: Assuming company XYZ has made an IPO in the price range of Rs 50-70 per share and the GMP is Rs 20 per share, then investors expect the shares of company XYZ to be quoted at 90 per share (Rs 70 + Rs 20).
Now let us assume a different scenario where the IPO of the same company was received cautiously by investors, resulting in the shares trading at a discount of Rs 15 per share in grey market. This suggests that the IPO could be priced at Rs 55 per share (Rs 70 – Rs 15) on listing below the cap price of Rs 70.
The investor needs to follow the IPO GMP trend performance to know the positive or negative sentiment of the investors.
How is IPO Grey Market Premium GMP calculated?
The GMP or grey market premium reflects the demand and supply dynamics of IPO shares. It is the premium that an investor is willing to pay to buy IPO shares in an unofficial grey market.
The GMP is an important indicator to measure investors’ sentiment towards the IPO. Broadly speaking, the GMP responds to investors’ perceptions of the IPO, the chances of share allotment and the number of public subscriptions to the IPO.
Subscription is an important indicator for calculating the GMP, because the higher the number of subscription figure shows high t demand for the IPO so, the GMP will be high or vice versa.
How to buy and sell IPO shares in the Grey Market?
Many of us do not know how to trade in the grey market. It is an unofficial market which does not come under the regulatory control of SEBI.
Those who want to buy shares in the grey market approach a local dealer or a grey market broker to buy a particular lot size at a quoted price or premium, known as GMP. Later, the broker finds potential sellers who have applied for the IPO but are not sure if they can win the IPO or who do not want to take the risk of holding the shares until the listing date. All transactions in the grey market are settled in cash. There are no formal contracts to conduct transactions in the grey market as they are based on mutual trust.
There is no physical transfer of shares in the grey market. Once the applicant has received the allotment, the shares are transferred to the buyers through the respective brokers. On the day of listing, the difference between the quoted price and the market price are settled. If the seller has not received IPO allotment, the deal is canceled.
Let’s take an example to understand how transactions are settled in the grey market.
Suppose an IPO is issued at an offer price of Rs 400 and in the grey market it trades at a premium of Rs 100. Now suppose a buyer wants to buy 15 shares at Rs 500 worth Rs 7,500 and a seller who has made an IPO application for Rs 400*15 shares worth Rs 6,000 can sell his application.
Now, assume that shares got listed at Rs 600. The profit and loss for the buyer and seller will be as follows:
- Seller’s profit: Rs 7,500 – Rs 6,000 = Rs 1,500
- Buyer’s profit: 15*600 = Rs 9000 – Rs 7,500 = 1,500
If the IPO gets listed at a price below GMP at Rs 450, the seller and buyer will earn below profits:
- Seller’s profit: Rs 7,500 – Rs 6,000 = Rs 1,500
- Buyer’s loss: 15*450 = Rs 6750 – Rs 7,500 = -750
Does GMP provide a correct estimation of IPO listing?
GMP is not a 100% true indicator of stock listing but it does reflect the dynamics of supply and demand. The GMP trend helps investors to get an idea of the expected share listing price.
Check out our IPO GMP Performance tracker page to compare the expected listing price at IPO GMP with the actual listing price.
What is IPO Kostak Rates and Subject to Sauda?
In the grey market, IPO applications are traded at Kostak prices or subject to Sauda prices.
Kostak Prices
Kostak price is the price agreed upon by both the parties of the grey market to deal in the IPO application irrespective of the allotment status. It is the price decided for the full application. It is price that a buyer has to pay to the seller even if the seller doesn't receive the allotment.
Suppose an investor has applied for the IPO for 30 shares (1 lot) for Rs 500; the total amount of IPO applications is Rs 15,000. Now a buyer who wants to purchase the entire IPO application can purchase it at a Kostak rate say Rs 2000.
Irrespective of whether the seller receives the IPO allotment or not, the Kostak price is paid by the buyer to the seller. If there is the listing gain and the seller receives the allotment, he transfers the shares to the buyer against receiveing payment of (15,000 + 2000) = 17,000. Thus allowing buyer to sell the IPO application for profit in the secodary market. If the seller doesn't get the allotment, still he is paid Rs 2000 by the buyer. With Kostak prices, payment is therefore made even if no allotment is made.
Subject to Sauda
Subject to sauda on the other hand is the price agreed upon by both the parties in which buyer only has to pay the agreed fix amount to the seller only if the seller receives the allotment. In the case of IPO applications that are traded subject to Sauda, the transaction only takes place in the event of a successful allotment; if the seller does not receive an allotment, the deal is canceled.
The prices for "subject to sauda" are generally higher than the "kostak rates".
