Whenever we search for an Initial Public Offer (IPO), we come across a widespread word known as GMP which is an acronym for Grey Market Premium. But, what is this all about, and what this market is? But the most important question for the investors like you and me is how this Grey Market affects the price of an IPO. We will try to understand the whole concept so that our investment decision can be made better.
Table of Contents
What is Grey Market?
IPO Grey Market is an unofficial market and unofficial means it has no regulations, hence SEBI has no say over it. No authority like SEBI, Stock Exchange, or Broker involves here and all the dealing is done in person and in cash only. And when you are searching for an unofficial entity, you should know that there is no guarantee or protection available to investors against their investments.
A Grey market is a place where the share of any company is traded before it is available on the stock exchange. That means you can sell and purchase the stock of the company even before it is opened at the exchange for trading. It is generally a small set of investors who have personal trust and bonding among each other, and you can trade the share here at Grey market at a certain premium called GMP (Grey Market Premium).
Two popular terms used in the IPO grey market are ‘Grey Market Premium‘ and ‘ Kostak‘.
Grey market premium (or grey market price):
GMP is a certain premium amount in rupees at which IPO shares are being traded in Grey Market before they get listed on the stock exchange. This grey market premium fluctuates as per the demand mechanism of the shares which is traded. If the demand for the share is high in the market, the premium of the stock GMP will be positive, and if less demand and no investors for that share then its Grey Market Premium will be negative. Grey market prices may suddenly drop or surge as there is no filter in place and no regulator is involved.
Buyer/Seller: You will find that Grey Market Premiums are always having one term Buyer or Seller with it mentioned. This word describes the price at which a buyer is willing to pay or seller is ready to sell their IPO shares
Example:
Clean Science India Limited
Issue Price: Rs 880 per equity share
Grey Market Premium: Rs 400 (Buyers)
This simply means buyers are ready to buy Clean India shares at 880+400 = Rs 1280.
Zomato Ltd
Issue Price: Rs 145 per equity share
Grey Market Premium: Rs -6 (Seller)
This means sellers are ready to sell zomato shares at the discount of Rs 6. i.e. 145-6 = Rs 139.
You must have observed that the Buyer term is associated with a positive while a seller is associated with a negative sign. Because when a negative sign is associated, it means sellers are ready to sell the share at that discounted price.
Kostak:
It is the name for the price of an application and it is the rate in rupees at which applications of IPO trades in the grey market. Kostak is important till the time IPO is closed for subscription and the final bidding status is available for investors. Normally IPO applications are not traded after the final bidding status closes for investors except for a few IPOs. ‘Kostak’ is especially for people who do not want to take risks with IPO allotment or listing gains. Unofficially, an investor can sell an IPO Application to a buyer at an agreed price (Kostak Rate) before IPO Shares are listed in the stock market.
Example:
Clean Science India Limited
Issue Price: Rs 440 Per Equity Share (at the upper band)
Lot Size: 14
Grey Market Premium: Rs 350 to Rs 360
Kostak (Rs 100000): Rs 2500 to Rs 2600
This means Clean Science India applications of Rs 1 lakhs are being traded in IPO Grey Market at Rs 2500 to Rs 2600.
Even though the Grey Market Premium of this IPO is around 75% of the issue price, the ‘Kostak’ is just 5% of the application amount. This is because Grey Market traders are assuming that the issue will highly oversubscribe and there will not be firm allotment even for retail investors who will apply the full Rs 1 lakhs. They are assuming one out of two people will get an allotment and thus Rs 2 lakh investment will give them an approximate Rs 5000 return. This way they are ready to buy 1 lakh applications for Rs 2500.
If there are more buyers than sellers the price goes up and vice versa.
In IPO Grey Market, the Kostak Rate is the amount paid for an IPO Application before the IPO shares get listed in the stock market. For example, XYZ Company came up with an IPO. The issue price is set at Rs 100 per share. The issue is expected to get listed in the next 15 days.
There are people who don’t want to wait for those 15 days to trade in XYZ Company’s shares. They started buying and selling the shares unofficially with the people they know. These transactions create a grey market for IPO Shares before listing.
One of the ways people sell their shares in the grey market is by selling the complete IPO Application to the buyer. For example, an investor applied shares of Rs 2,00,000 in XYZ Company’s IPO. He is not sure how many shares he will get allocated and what listing gains he may get.
On another side, there is a buyer who says I am ready to take the risk. Sell me your Rs 2L IPO application at Rs 5000. If the seller agrees, he could make the deal and get Rs 5000 and exit from this transaction. This Rs 5000 is the Kostak.
What is ‘Subject to Sauda’ IPO Grey Market?
This is also a kind of deal (obviously unofficial) in the IPO grey market between Seller and Buyer where the deal is on if the seller gets an allotment of shares. If the seller doesn’t get an allotment of shares, the deal gets void. For example; a company XYZ is coming up with an IPO at the price of Rs 100 per share. IPO Shares are expected to list in 15 days. A seller can sell his Retail IPO allocation of Rs 2 lakhs for Rs 5000 on ‘Subject to Sauda’. If the seller gets an allotment, he will get Rs 5000 But If the seller doesn’t get an allotment, he won’t get anything.
Can you trade in the Grey market?
Since the Grey market is an unofficial and uncontrolled market so you will not find an office or counter where you can approach and apply. It is like a counter market where you have to search for any local dealer who must be in contact with the grey market and can help you in trading with Grey Market. Grey Market is operating only in some cities of the country like Mumbai, Jaipur, etc.
How does Grey Market work?
There are two ways in which the grey market works and we will look into each:
Option 1: Trading IPO Allocated Shares:
Suppose an investor/seller applies for an IPO application and he is taking risks associated with non-allotment, or allotment with discount. He wants to minimize these risks and so he contacts with dealer for selling the shares if allocated to save himself from the listing loss etc. At the same time, there are some investors / Buyers who think in other ways and look for the scope of those shares. They think that these shares are value stocks and so want to retain them. So, these buyers will start collecting these shares before the shares get allocated by the registrar legally.
Now Buyers will contact dealers of Grey Market and will place the order to buy IPO at a specific coupon rate or premium called Grey Market Premium. Now, the Dealer will contact the seller who applied for the IPO and will ask him about his willingness to sell the shares (if he gets an allotment) at a grey market premium. Please keep in mind that these things happen even before the IPO gets allocated by the registrar.
Now, if the seller like the rate or premium and is not willing to take risk of stock market listing, he may sell the IPO shares to the grey market dealer and book the profit. At this time the seller has to finalize the deal with the grey market dealer at a certain price. Once the deal is done, the Grey market dealer will get the application detail from the seller and inform the buyer that he bought a certain number of shares from the sellers in the grey market.
Once the Allotment process is done and sellers may or may not receive an allotment of shares. If shares are allocated to the investor, either he may get a call from the dealer to sell them at a certain price or to transfer allocated shares to some Demat account. In the case of selling the shares, settlement is done based on the profit or loss and the grey market premium at which buyers and sellers made a deal. If no shares are allocated to the sellers the deal gets canceled without any settlement.
Option 2: Kostak – Trading IPO Applications in Grey Market
Suppose an investor/seller applies for an IPO application and he is taking risks associated with non-allotment, or allotment with discount. He wants to minimize these risks and so he contacts with dealer for selling the shares if allocated to save himself from the listing loss etc. At the same time, there are some investors / Buyers who think in other ways and look for the scope of those shares. They think that these shares are value stocks and so want to retain them. So, these buyers will start collecting these shares before the shares get allocated by the registrar legally.
Buyers decide the price of the application based on various assumptions and market conditions. They give an offer to the sellers that they are willing to buy an IPO Application (without knowing how many shares will get allocated) at a certain premium.
To avoid the risk of allocation, the seller may sell their application at a certain premium to the buyer through a grey market dealer. This kind of trading is called application trading or ‘kostak’. In the case of ‘Kostak’ the seller needs not to worry about the share allotment in IPO. Whether he receives the allotment or not he will get the premium at which he sold his IPO allocation.
Grey market dealers get the application detail from the seller and send a notification to the buyer that he bought an IPO application at a certain premium from the sellers in the grey market. Once the allotment is done by the issuing registrar, the seller who sold his application in the grey market may or may not receive an allotment of shares.
If shares are allocated to the sold application, the seller may get a call from the dealer to sell them at a certain price or to transfer allocated shares to some Demat account. In the case of selling the shares, settlement is done based on the profit or loss. If no shares are allocated to the sellers the deal is over without any settlement. The seller still gets his premium as he sold his application.
Let’s take an example of RBL bank where the Issue price: is Rs 225, Lot size: is 65 Shares, Kostak: is Rs 700, GMP: is Rs +40 (seller)
Now if you applied for IPO and willing to sell in the grey market, you will get 700 from the buyer.
Now Share got listed at Rs. 300 which is Rs. +75 Premium over the issue price of Rs. 225. Suppose you got an allotment. So you will sell your shares at the listed price or above it. So the Capital Gain to your account is Rs. 75 (300-225)*65 Shares = Rs. 4,875. But as decided you can have only 700, so the Balance is the profit of the buyer for taking the risk. You have to pay him Rs. 4175. But if you didn’t get the allotment, he will pay you 700.
Shall we consider GMP before applying for an IPO?
It is an individual choice and you can consider GMP for the application for IPO. Generally, those IPO having a GMP in positive attracts demands in the market and oversubscribe at the exchange. The reverse is also true, but this is not a guarantee that any IPO having a positive GMP will surely give a good listing gain. So, it’s better to check the fundamentals of the company before applying for an IPO.
Tax implications for selling shares in the grey market:
The seller is liable to pay Short Term Capital Gain(STCG) on the actual profit he made by selling the share in the stock market. To understand it better let’s take an example of the DMart IPO- having one lot of 50 shares at 300 per share means the price of one lot you paid is 15000.
DMart IPO applications were sold in the grey market at Rs 2500 (kostak). Let’s say you sold your application in the grey market prior to allocation happening. Now, you got allocated the shares (one lot of 50 shares) at 300 per share. DMart’s share gets listed at 650 on the first day and you already sold all 50 shares in the grey market. So, you will receive your 32500 (50*650) and so you made a profit of 17500 for this listing gain.
Here comes the tricky part, as you sold your shares in the grey market so you have to give 15000 to the grey market dealer in cash and it will leave only 2500 with you as profit. Now you have to pay STCG @15% OF THE PROFIT OF 17500 i.e. 2625. So overall you lost money Rs 125 in this transaction.
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Is Grey Market Kostak and Subjected to Sauda different?
The Grey market Kostak is the premium you get irrespective of the allotment status. For example, if you sold your IPO application for a Kostak price of Rs 1200, you will get Rs 1200 for sure. No matter if you get an allotment or not. The Grey market Subject to Sauda is the application premium that is applicable only if you get the allotment. For example, if you sell your IPO application in the grey market as Subject to Sauda for Rs 4500, you will get this money only if you get an allotment.