You must have seen fluctuating prices denoted in red and green on your trading terminal. But what if I tell you the colour grey also holds a huge significance in the stock markets. It is associated with Initial Public Offers (IPO). Specifically, Grey Market IPO.

Let’s understand what is grey market IPO, how it works and more.

What is Grey Market IPO?

To understand grey market IPO, first you need to know what is a grey market?

A grey market is an unofficial market. Here goods are sold outside the official distribution channels. If you have ever bought a branded camera or a watch for a fairly less price than its MRP, then you might have purchased it from the grey market. In a grey market, goods are sold by unauthorised dealers. One thing to note here is that a grey market is an unofficial market, not an illegal market.

Similarly, grey market IPO is a market where individuals buy and sell IPO shares or applications before they are listed on the stock exchanges. As this is an unofficial market there are no rules and regulations. All transactions are mutually settled. None of the regulatory bodies like Securities and Exchange Board of India (SEBI) or exchanges like National stock exchange (NSE) and the Bombay stock exchange (BSE) are involved in grey market IPO transactions.

Watch this video to learn everything about Grey Market IPO. 

Why Do People Trade in Grey Markets?

Trading in the grey market has always been in trend. Traders and investors who believe that a stock has the potential to list at high valuations usually trade in grey markets. It is an excellent money-making opportunity as you can buy shares at a discounted price. Investors who have missed the application deadline for an IPO, can directly apply for shares from the grey market.

Grey market prices work on the basic principle of demand and supply.

• Higher the demand, higher the prices
• Higher the supply, lower the prices

Grey market valuations also help underwriters determine the demand of shares in the market before listing. Another reason people trade in the grey market is that it gives them an opportunity to exit the IPO before it is even listed.

In a grey market, both IPO shares and IPO applications are traded. The three most common terms associated with grey market IPOs are grey market premium, kostak rate and subject to sauda. Let’s understand each of them.

What is Grey Market Premium (GMP)?

Grey market allows traders to trade in IPO shares even before they are listed. This is done at a premium known as grey market premium (GMP). It is the additional amount over the IPO price that investors are willing to pay to buy the shares.

For instance, a company has come up with an IPO. The issue price is Rs 100. The grey market premium is Rs 30. This means that the investor is willing to pay Rs 30 above the issue price and buy the shares at Rs 130 (Rs 100 + Rs 30). He does this because he believes the stock will list at an even higher price. Hence, he doesn’t mind paying a premium for these shares.

On the contrary, imagine if the grey market premium is (Rs -30). This means that the investor is willing to sell the shares at a discounted price of Rs 70 (Rs 100 – Rs 30). This is because he is expecting the shares to list at an even lower price.

Grey Market Premiums and their Implications

• If the grey market premium is high, investors are positive that the share might perform better upon listing.
• If the premium is low or negative, investors are uncertain about the performance of share upon listing.

By analysing GMP you can easily gauge how the stock might perform on the listing day.

One thing to note here is that GMP is not always constant. It keeps fluctuating according to the demand and supply of shares. Also, the sentiments of the stock market tend to affect premium prices to a great extent.

What is IPO Kostak Rate?

Kostak Rate is the profit a seller makes by selling his IPO application in the grey market. This is done before the shares are allotted.

For instance, a company has come up with an issue price of Rs 15,000 per lot. In the grey market the kostak rate is Rs 1,000.  This indicates that buyers are buying the entire application at Rs 16,000 (Rs 15,000 + Rs 1,000 kostak rate) per lot in the grey market.

In this kostak trade, Rs 1,000 is the profit a seller makes even if shares are not allotted to him. If shares are allotted, then he keeps Rs 16,000 and gives the rest to the buyer if there is a profit. If the sale of shares gets less than Rs 16,000 then the buyer pays the difference.

But even if the buyer approaches 50 people with kostak rates, it does not guarantee allotment to everyone. Hence, to avoid such risk subject to sauda is applied.

What is Subject to Sauda?

The grey market subject to sauda is the premium that is applicable only if you get the allotment. Here the premium is higher than kostak rate.

Example: If you sell your IPO application in the grey market as subject to sauda for Rs 3,500, then you get to keep this profit but only if you get an allotment.

Kostak and subject to sauda is usually done by the seller to lock-in the profit before listing. While the buyer is quite positive about the issue and purchases the application to earn high listing gains.

How Does Trading in the Grey Market IPO Work?

Grey market trading can be done in two ways:

1. Trading IPO shares
2. Trading IPO applications.

Trading IPO Shares 

1. Investors who apply for an upcoming IPO are uncertain about the performance of shares upon listing and hence they try to sell their shares in the grey market and book profits. They are sellers in the transaction.
2. Investors who think that the shares are valued more and might list at a premium try to collect shares from the grey market. They are the buyers in the transaction.
3. Buyers contact grey market dealers to buy shares at a certain grey market premium (GMP).
4. Grey market dealer’s approach sellers who have applied to sell the shares.
5. If the GMP is acceptable to the seller, the deal is finalised. Later, the dealer collects the application details from the seller and informs the buyer about the purchase.
6. The seller may or may not receive the allotment of shares.
7. If the shares are allotted, the seller has to transfer the shares to the buyer’s Demat account or sell it in the open market and settle the difference.
8. If shares are not allotted to the seller, the deal gets cancelled without any settlement.

Trading IPO Applications

1. The trade takes place between two parties – the buyer and the seller. The buyer is bullish about the issue and hence he wants to buy the entire application of shares.
2. On the other hand, the seller wants to book profit before the shares are listed. This profit is known as the kostak rate.
3. The buyer contacts the seller with the help of a grey market dealer. He offers to sell the application at a certain kostak rate.
4. By selling the application, the seller locks-in his profit. Even if the shares are not allotted, he gets to keep the kostak amount.
5. If the seller agrees to sell the shares, the deal is finalised. The dealer collects the application details from the seller and informs the buyer about the purchase.
6. If the shares are allotted, the dealer contacts the seller and asks him to transfer the shares to the buyer’s Demat account or sell the application at a certain price on listing.
7. If shares are not allocated to the seller, the deal is cancelled. However, the kostak rate is the profit made by the seller.

Are Grey Market Trades Taxed?

Yes, the seller has to pay short term capital gain on the actual profit he has made by selling the shares upon listing.

Let’s understand the process with an example.

Suppose you had applied for an IPO application of Rs 15,000 (50 shares of Rs 300 each). Later you sold the application in the grey market at subject to sauda for Rs 4000.

Luckily you got an allotment and the share listed at Rs 600. As per the deal with the buyer, you sold the shares and got Rs 30,000.

Now, you have made a short-term profit of Rs 15,000. Out of this you will keep Rs 4,000 and pay Rs 11,000 to the seller in cash.

As the profit earned is short term capital gain, you will be taxed at 15% on the total profit. So, your tax liability on this transaction is Rs 2,250.

Your in-hand profit is Rs 1,750 only (Rs 4,000 – Rs 2,250).

Are Grey Market Trades Legal?

No, grey market trades are illegal. We strongly recommend you to NOT trade in the grey market.

All grey market trades are undertaken on the basis of trust. So, there is substantial counterparty risk involved in grey market transactions.  Since, there are no regulatory bodies involved, trading in the grey market is considered risky.

List of Recent IPOs with Their GMP and Kostak Rates

* This is simply a list. The GMP and Kostak rates might vary

You can easily check the performance of all recent IPOs with BSE IPO Index. Click here to know more.

Final thoughts – Grey market IPO

Remember grey market trades are illegal. If you are a retail investor and did not get the IPO allotment, then don’t worry. Our chief markets editor Apurva Sheth has discovered an IPO investment strategy which will show you how to make money in an IPO even without allotment.

You can simply follow our views and recommendations on our YouTube channel and subscribe to never miss an update.Open a free Demat account to apply for upcoming IPOs. Explore the detailed guide on IPOs by clicking here.