Understanding of Grey Market Premium in IPO

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Grey Market premium on IPO

 

Many of us know about the black market that typically involved illegal transactions is outside of the official economy. If any company announced the Initial Public Offer, most of the investors worry about the grey market premium and kostak price.

Beginners have confused about these terms, let us have a brief discussion on it. We have spoken quite a lot about this section in many articles related to IPO like Burger King IPO.

Kindly have a look at our article on Peak Margin Rule.

 

What is Grey Market? 

 

Generally known as the parallel market, where unlisted securities are bought and sold outside the exchange. An IPO grey market is an unofficial market where traders bid and offered the company shares. This bidding takes place before the shares list on the stock exchange.

It’s an OTC (Over the Counter) Market where IPO shares and application of the stocks are bought and sold. All transactions in this market are done via cash-settled. Remember one thing it’s not regulated by SEBI or any other regulatory bodies in India. None of the stockbrokers involved or backed by the grey market transaction.

All transactions in the grey market is based on the trust build on the opposite party. If the counterparty failed to obligate the transaction, we can’t file the case in court.

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We must understand that grey markets are unregulated and trades are settled within a small group of trusted people. It allows the merchant bankers and issuers to determine the demand and supply of the company. It will give an idea about, how the investors see the future potential of that company.

 

Grey Market Terms:

 

We should aware of two basic terminologies in the grey market.

  • Grey market premium
  • Kostak

Grey Market Premium:

 

It’s the additional amount over the IPO price that investors are willing to pay to get the shares in the grey market. Let’s assume the issue price for stock X is Rs. 60.

If the grey market premium will be traded 50% premium that means people are ready to buy the shares of the company X for Rs 90 (60+ 50% of 60). In the same way, some stocks would be traded at a discounted price.

 

Let us take one example, Ravi is a stock market trader and he applies for the IPO shares of almost 500 shares in his trading account. Meanwhile, some of the other investors predict the value of the share is much higher than its issue price. These people ready to pay higher than the issue price and they approach grey market dealers to find the sellers of IPO shares.

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For example,  dealers contact Ravi for making the deal. If he doesn’t want to take a risk on listing day, he sells his shares to the buyers and books the profit.

 

IPO Applicant (Seller) ——–>Dealer———->Buyer

 

Kostak:

 

We can also trade the IPO application in the same way as grey market premium but the difference is, applications are traded after the IPO application window closed. This is called kostak price.

Let us understand in a simple way, if you have a trading account and apply for the IPO Later on you don’t want to subscribe, in this case, you can sell your application to an interested buyer in the grey market who will take a risk. The profit you make is kostak rate.

For example, you apply for the IPO for that you invested 100000, but you don’t want to take the risk and sell it in the grey market at 10000 Rs for a single application. If the buyer ready to accept the deal, he will make a payment of 110000 to the seller.

You must be wondering, if a stock is listed 400% premium on listing day, the buyer will get the additional benefit of this investment. It’s not like buyers will get maximum profit in this transaction, he must pay the short term capital gain tax (15% of the profit) and Kostak price also.

Also Read on FinMedium:  Dodla Dairy Ltd IPO: Should You Subscribe?

Please have a look at our article on Biocon Share price Qualitative Analysis.

 

Key Takeaways:

 

  • This gives a fair idea of the demand and supply of the stocks before traded in the exchange.
  • It’s a reflection of a small group of people not a whole. This will not directly affect the listing price of the IPO.
  • We can’t judge the exact demand for the stock in the grey market.
  • It gives an opportunity for the premium buy of demanded stocks and also give an exit way for the discounted stocks.
  • We hope our readers get enough idea about the topic. Before applying for an IPO, check the fundamentals of the company, and analyze the financial parameter to predict the future potential of that company.



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