It is important to understand what you are investing in, especially when it comes to IPOs. Lately, there has been a growing buzz around investing in IPOs among Indian retail investors, and right at the centre of this buzz is something called the Grey Market Premium (GMP).

GMP shows how the market feels about a company’s public debut before it actually happens. In this comprehensive article, we will help you learn how are IPO shares traded in the grey market. Let’s get started!

What is GMP in the Stock Market?

Before shares are listed on the stock exchange, there is often a flurry of activities that take place behind the scenes. This is where the grey market comes into play. In this space, IPO shares are bought and sold off the record, i.e., outside the regulated exchanges. These transactions happen informally, and therefore, the Securities and Exchange Board of India (SEBI) has no control over them. 

This means you step into a world where the usual rules do not apply. Naturally, you cannot use your demat account or any online trading platform to invest in an IPO via the grey market.

The grey market operates on sentiments such as what people say, how the broader mood shifts, and what informal trader networks believe will happen. If the IPO creates a positive sentiment in the market, investors are willing to pay a higher premium. This higher premium is known as GMP. 

Understanding the Grey Market In India 

Now that we have understood what GMP is in the stock market, let’s learn more about the grey market itself. The grey market is an unofficial market that enables you to trade in IPO shares before they are listed on the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE). 

Knowing how the GMP works gives you a clearer picture of IPO sentiment before the stock officially lists on the exchange. GMP occurs when the shares of an IPO get traded in the grey market for a higher price than the IPO’s actual issue price. 

This gap shows how much early excitement or confidence there is among investors before the stock is launched in the public market.

GMP Formula:

GMP = Grey Market Price – Issue Price

Example:

Say an IPO, priced at Rs. 600 is being traded at Rs. 700 in the grey market. This means the GMP is Rs. 100. GMP shows that  people are willing to pay Rs. 100 more than the offer price, expecting the share to list at a premium once it goes public.

Why Does the GMP Matter For an Upcoming IPO?

Even though it is informal and unregulated, GMP often gets attention from investors for a good reason. Some reasons include: 

  • A high GMP usually signals a strong interest in the IPO.
  • You can use it to estimate potential short-term gains post-listing.
  • It can give you an early read on market demand for a specific company.
  • For short-term traders, GMP can influence where to apply and how much to invest.

How Do We Determine GMP?

GMP is not something defined by stock exchanges or official regulators. Instead, it reflects a mix of market trends and community sentiment. Factors that impact GMP include:

  • Qualified Institutional Buyers (QIBs), Non-Institutional Investors (NIIs), and retail investors might invest in an IPO through the grey market. If the QIBs and NII investments are on the higher side, the retail investors get more interested in the IPO, as these institutions do not invest without due research. It automatically increases the IPO’s GMP in the grey market. 
  • A company’s financial performance and brand reputation also determine the GMP. 
  • Market trends and how similar IPOs have historically performed can impact the GMP. 
  • Speculative interest and demand from informal investor networks also boost the GMP. 

Types of Grey Market Practices

Now that you have a fair understanding of what grey market premium is and how it works, let us explore the types of trading taking place in the grey market: 

  1. Trading of IPO Shares in the Grey Market

This means trading IPO shares before they are officially listed on the stock exchange. When you purchase shares this way, you pay the issue price along with the grey market premium (GMP).

  1. Kostak Trading

Kostak trading is that of IPO applications in the grey market. It takes place on the basis of the kostak rate, which is the fixed price someone pays for your IPO application, regardless of its allocation status. For example, if someone offers you Rs. 1000 for your application, they take over any shares allotted and any resulting gains or losses.

  1. Subject to Sauda 

Sauda agreements are informal deals that take place based on allotment outcomes. If no shares are allotted, the deal does not go through. If they do get allotted, ownership and gains are transferred as per the original agreement.

Does GMP Always Show Accurate Results?

GMP can be helpful, though it sometimes gives inaccurate results. Here is why:

  • GMP is not controlled by SEBI or any official regulation. Therefore, it is open to being affected by the opinions of investors.
  • GMP may change each day because of market trends and changes in subscriptions. So, it is unpredictable in this sense. 
  • GMP does not confirm the listing price of a share in any way. Unexpected changes in the market, important news, or weak finances may still lead to a change in listing price.

Problems with Grey Market Transactions 

Here are some things to be aware of before engaging in trading in the grey market: 

  • As grey market deals are not official, you cannot rely on anyone to help if something goes wrong.
  • Some might use GMP numbers dishonestly to spark public interest.
  • Between the time the IPO closes and the company gets listed, the market conditions can shift drastically.
  • Before using GMP, you should understand that it relies more on the market sentiment and therefore, you must rely on it as an investment suggestion.

Final Thoughts

An IPO’s grey market premium gives you an idea of what other investors expect from the company and the broader market. It can be useful if you’re looking to invest for the short term and aim to profit from the listing. However, you shouldn’t rely on it as the main factor in your investment decision.

Instead, take a closer look at the company’s fundamentals, how it runs its business, its financial track record, and its current valuation. The grey market premium is just one piece of the puzzle. To make well-informed decisions, you still need to build a balanced portfolio.

Gain more knowledge about stock market investments and trending IPOs on Share.Market, your go-to platform for investment insights and stock market news! 

FAQs on Grey Market Premium in IPOs

1. What is GMP in the stock market?

GMP refers to the difference between investors’ willingness to pay for an IPO share and its stock exchange value. It represents the attitudes of market buyers and traders, letting them guess the potential for an increase in listing prices.

2. What is the grey market, and how does it work?

The Grey Market allows trades of shares and applications from upcoming IPOs without waiting for them to be officially listed. Since it is outside the control of official bodies like SEBI, it depends on unauthorised dealers and brokers. People make trades based on trust, speculation, and how the market is feeling.

3. Which types of trading take place in the grey market?

These are three common types of trading that happen in the grey market.

  • GMP Trading: Get shares at the issue price plus the GMP value.
  • Kostak Rate Trading: Pricing each IPO application to help them sell fast.
  • Sauda Trading: You can trade conditionally according to the IPO results. Such methods are not standardised and allow traders to try and profit before an item is listed.

4. How are IPO Shares Traded in the Grey Market?

Unregistered shares from IPO can be purchased in the grey market from local dealers and brokers ahead of listing. They agree on a premium and then trade money or shares without a formal agreement. All these transactions rely on luck in the draw and work like a gamble, with no monitoring from regulators.