GMP of IPO | What is IPO GMP | IPO Grey Market Premium Rate

IPO The grey market is an unofficial and informal market in which IPO shares are exchanged before their official listing on the stock exchange. The IPO Grey Market is an unregulated and operated market, but its presence is critical for every IPO since it informs potential investors about share market sentiment and demand for the IPO.

• The Grey Market Premium is the premium price that an investor is ready to pay in the grey market above the IPO issuance price. The Kostak Rate, also known as the Subject to Sauda, is the price at which IPO applications/lots are offered in the Grey Market.
• In this chapter, we will learn about the fundamentals of grey market trading, as well as the terminologies and tactics employed in its execution.

IPO Grey Market Premium Meaning

• The Grey Market Premium (GMP) is the differential between the price at which IPO shares are exchanged in the grey market and the IPO issuance price. For instance, suppose the IPO issue price is Rs 850 and an investor is willing to spend an extra Rs 300 to obtain an IPO share. This indicates the IPO’s GMP is Rs 300 per share.
• IPO GMP aids in the prediction of listing prices. In the above scenario, investors expect a listing price of Rs 1,150 (IPO issue price plus GMP, i.e. 850 + 300). Although there is no assurance that the IPO listing price will exactly match the GMP, the GMP is one of the most important indicators for investors to predict the IPO price and make an investment decision appropriately.

IPO Grey Market Dealers

• Unauthorized persons who acquire and sell IPO shares on an unofficial market (over-the-counter market) are known as grey market traders. In some circumstances, grey market dealers are also required to underwrite a particular percentage of the IPO.
• There are no registered traders in the IPO gray market because it is an unregulated and unofficial industry. Check with local dealers to determine whether they participate in the grey market and can assist you in finding buyers and sellers for your transactions.

Trading in Grey Market

Trading in the IPO grey market begins after the IPO issue price is announced and continues until the shares are listed on the exchange. Some of the key characteristics of IPO grey market trading are as follows:

• Unofficial and unregulated market.
• Trading in the grey market takes place usually via telephone calls.
• Settlement of trade happens only in cash, generally using the services of Angadia.
• Transactions in the grey market are based on mutual trust.
• Round-the-clock market that works 24*7.
• No regulatory body governs IPO grey market trading.
• No official or registered dealers are involved.
• No formal contracts are issued for transactions conducted in the grey market.

Typically, three people are involved in grey market trading: the buyer, the seller, and the dealer. Grey market trading occurs through the exchange of IPO shares or IPO applications.

• To trade in the grey market, an investor must first locate a grey market dealer. Because grey market transactions are based exclusively on trust, the dealer acquires customers through referrals. Thus, an investor can begin trading in the grey market if he is introduced to a dealer by a trustworthy source.
• Once an investor has located a dealer, he can place an order over the phone. Trading in the grey market begins as soon as there is news of an IPO in the market and continues until the previous day of listing. The settlement takes place at 9.45 a.m. on the listed day. Once the IPO is listed, the grey market window for the IPO is closed. Grey market trades likewise have a 90-day expiry term. The agreement is terminated if an IPO does not take place within 90 days of the gray market transaction date.
• On the day of the listing, the dealers enter their buy/sell orders based on their net delivery position at the equilibrium price.
• The deals are recorded using Excel sheets or simple Tally tools. On the day of settlement, the angadia goes door-to-door to recover/deliver cash.
• There is nothing anyone can do if either of the counterparties defaults. Trading in the grey market is so dangerous.

IPO Grey Market Rate Types

1. IPO Grey Market Premium (GMP)

The IPO GMP price can be positive or negative.

• If the GMP value is positive or very high, this indicates that the IPO may perform better on listing or bumper listing. Example: If the IPO issue price is Rs 500 and the GMP is Rs 150, the listing is likely to be at Rs 650 (30% gain).
• If the premium is low or negative, investors may be uncertain whether the stock will be successful after the listing and expect the listing to be at a discount. Example: If the IPO issue price is Rs 500 and the GMP is Rs – 200, the listing is expected at Rs 300.

Example of GMP with listing gain

If the IPO issue price is Rs 500 and the GMP is Rs 300. It means that buyer A in the grey market is willing to purchase the share at Rs 800.

Suppose an IPO applicant i.e. seller B of IPO shares in the Grey market has 15 shares. He has applied to Rs 7,500 (15*500).

The grey market buyer A will pay Rs 12,000 (15 * 800) against the IPO application value of Rs 7,500 (15 * 500).

Now let us say if the listing happens at Rs 1,200, the buyer and seller will earn below profits:

• Profit for seller B of the IPO shares: Rs 4,500 (12,000-7,500)
• Profit for buyer A of the IPO shares: Rs 6,000 (18,000 – 12,000)

Example of GMP with listing loss

Continuing with the previous example, if the stock is listed for Rs 600, the profit/loss for both parties will be as follows:

• The application amount for 15 bids will be 15*600 = Rs 9,000, based on the listing price of Rs 600.
• Profit for IPO share seller B: Rs 4,500 (12,000 – 7,500).
• Buyer A’s loss on the IPO shares: Rs 3,000 (9,000 – 12,000).
• The seller’s profit level remains constant. However, the buyer suffered a Rs 3,000 loss because the listing was below the GMP.

2. Kostak Rate

• The IPO Kostak price is an agreed-upon price at which IPO applications, regardless of allotment status, are sold and purchased. The Kostak Price is the fixed price paid by the IPO Application buyer to the IPO Application seller.
• The Kostak rate is the total price of the IPO application, not per share. It is a price agreed upon by the buyer and seller.

Example – In an IPO for Rs 7500, an investor applied for 15 shares at Rs 500 each. Another investor is excited about the approaching IPO and is willing to pay Rs 1,000 as a premium to purchase the full IPO application. In this situation, the seller of the IPO application earns a predetermined fee of Rs 1,000 regardless of whether or not he receives an allotment.

• If the seller receives allotment and the listing occurs at a premium, the seller must pass on the listing gains to the buyer or credit the shares to the buyer against Rs 8,500 (7,500 +1,000).
• If the seller does not obtain the allotment, the buyer of the IPO application must still pay Rs 1,000 to the seller.

3. Subject to Sauda

• The IPO Kostak rate is extended by the Sauda price. The buyer of the application undertakes to pay a specified price against the IPO application only if the seller of the IPO application receives allotment in the IPO, according to Sauda. Rates subject to Sauda are often higher than Kostak rates.
• In the preceding example, the buyer of the applicant commits to pay an additional Rs 4,000 for the complete application if the IPO applicant is allotted.
• If the applicant does not receive an allotment, the transaction is terminated. If the IPO applicant wins an allotment, the buyer of the IPO application pays a premium of Rs 4,000. The applicant’s seller either passes on the listing gains or shares to the buyer of the IPO application for Rs 11,500 (7,500 + 4,000).
• Note: Rs 7,500 is the amount paid to purchase 15 Rs 500 shares. The buyer paid a premium of Rs 4000 for the full application.

IPO Grey Market Premium Vs Kostak

Grey Market Premium vs Listing price

Grey Market Trading Pros and Cons

Advantages

• Increases the chances of making a profit from the IPO.
• Availability of IPO shares for trading even before listing or subscription.
• Ability to purchase IPO shares even after the IPO subscription window closes.
• No limit on the number of IPO applications for trading.

Disadvantages

• A high amount of risk is involved as the market is unregulated.
• No grievance forum in case of any fraud or issues.
• Chances of losses in case of listing at a discount.
• No written or official agreement to buy or sell; hence no proof to serve.

Grey market premium is good or bad

When handled correctly, the grey market can be helpful. It is one of the indicators used to forecast listing prices. The grey market can be utilized as an effective hedging strategy rather than for gambling. GMP is based on market sentiment as well as the demand and supply of IPO shares and provides a reasonable estimate of IPO listing.

Even though the GMP is not always correct, investors should keep an eye on it because it can help them analyze their investment decisions as well as the performance of an IPO after listing. On Chittorgarh.com, under the GMP tab of each IPO, you can view the IPO GMP live statistics or the IPO GMP performance tracker.

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