How do you comprehend the grey market in stock trading?
A grey market is an unofficial market where IPO (Initial Public Offering) trading takes place. It is not recognised by SEBI or any of the Indian depositories. It is also referred to as a parallel market because stocks are traded here before they are launched on the stock exchange. Similarly, IPO trading takes place in the grey market before it is available to the public through official trading platforms. A company that wants to verify the demand for its IPO before its launch may introduce it in the grey market. As it is an unofficial trading market, the trading activities like buying and selling are to be done in cash. Therefore, interested traders will need to be present in person to carry out the trading activities. A few people manage and handle the activities of the grey market. It is mainly present in metropolitan cities like Mumbai, Ahmedabad, Kolkata, etc.
In India, grey markets have been operational for quite some time now. Even experienced investors and traders monitor the activities of grey markets closely to evaluate the performance of the stocks before they are listed. The grey market allows investors to buy an IPO even if the deadline has already been crossed. Similarly, if an investor doesn’t want to hold the IPO, he may be able to sell it in the grey market. If an IPO is available in the grey market before it gets listed on the stock exchanges, it is known as Grey Market Stock. Though grey market IPO trading is carried out with mutual trust, it is not authorised by any legal entity. Also, the trading activities that take place in the grey market settle only once the official trading happens after the stocks get listed.
The trading of IPO shares in the grey market happens in two types. In the first type, the IPO shares which are allocated get bought or sold before the stock exchange listing happens. In the second type, IPO applications are bought or sold at a premium. Premium refers to the rate above the IPO’s original price. It is determined by the amount that the grey market traders agree to pay over the original price of the IPO.
There are two types of traders in the grey market. Sellers are those investors who feel that the IPO issue price will fall in the stock market once it gets listed. However, some investors feel that the IPO issue price will increase once it gets listed in the stock market. Such investors are known as buyers. The buyers need to contact the grey market dealers to buy a particular IPO. The dealers then contact the sellers who have already applied for the IPO and request them to sell their IPO in the grey market. If the demand for the IPO is more, the seller can sell the IPO at a grey market premium. Even the grey market dealers purchase the IPOs at times at a fixed amount. The sellers who don’t want to bear a loss once the IPO gets listed usually sell the stocks to these dealers. After purchasing the IPO shares from the sellers, these dealers notify the buyers who might be interested in buying them.
Once the IPO shares get allocated to a seller, he may directly transfer them to the buyer via his Demat account or sell them at a particular price point. If the IPO shares do not get allocated to the seller, the deal or trading between the buyer and seller through the grey market dealer cancels automatically.
What is GMP?
GMP or Grey Market Premium is usually referred to as the rate at which an IPO share is being traded in the grey market. For example, if the price of a particular IPO share is Rs. 500 and the GMP of that particular IPO share is Rs. 600, it means that the grey market traders are willing to buy the share at Rs. 1100 (Rs. 500 + Rs. 600).
The grey market premium can also be negative. It usually happens when there is a negative perception about a particular IPO share among the investors or when the demand for the IPO share is relatively lower among retail investors and traders. In such cases, the price of the IPO share or GMP is below the original price of the stock. For instance, if the GMP of an IPO share is -40 and its original price is Rs. 500, the buyers will be able to buy it at Rs. 460 (Rs. 500 - Rs. 40). Therefore, it is quite evident that GMP can be either positive or negative. The GMP price keeps changing constantly until the stock gets listed. The GMP can also be an indicator of the latest price-related trends for an IPO share. However, most investors or traders don’t consider it to be an accurate indicator of the current price trends due to the following reasons:
- The grey market is quite small if we compare it to the official stock market. Therefore, its sample size can be too small to indicate the demand for the IPO share accurately.
- Manipulation in GMP is possible as the grey market trading is not official and is prone to manipulations.
- The fundamentals and economic activities and trends also influence the price of the stocks. As a result, GMP trends are not final for estimating a stock’s direction by any means.
- Grey market premiums can often be misleading for traders. It is because IPOs are mostly used for making a profit on the day the stock gets listed. Therefore, even if GMP indicates a higher price, it may go below the issued price due to rampant selling on the listing date. As a result, the trader might suffer heavy losses if he only depends on the GMP price trends.
Once the stock gets listed, it is available for trading officially and therefore, the grey market trading for that particular stock automatically ends. However, as grey market trading is based on mutual trust, the sellers, buyers, and dealers need to settle the shares that are bought or sold in the respective accounts. There is no legal framework for tracking or resolving the trading malpractices that take place in the grey market. Therefore, it proves to be a risky proposition, especially for a new trader.
What is the importance of the grey market?
Trading that takes place in the grey market cannot be settled in the grey market itself. It gets settled only once the IPO gets listed as a stock on the stock exchange. Therefore, there is a certain degree of risk associated with this type of trading. As a result, numerous pension funds, mutual fund houses, and investors don’t participate in or encourage grey market trading. Even then, the grey market has its own importance because of the following reasons:
The performance of a particular IPO share or stock in the grey market gives an idea of how it will be performing after getting listed. Therefore, numerous traders, broking firms, and brokers take an interest in the grey market proceedings.
Usually, the demand for an IPO share or stock is too high but the shares or stocks are limited in number. Therefore, they might not be available for bidders easily. If retail investors or traders are keen on buying a particular IPO share or stock before it gets listed with an assumption that it will grow in value once it gets listed, they can think of buying it from the grey market. The grey market is therefore responsible for maintaining the demand and supply of IPO shares to some extent.
Sometimes, an investor might get insights regarding the deterioration of an IPO share after it gets listed on the stock exchange. In such situations, the investor might foresee a huge loss and would want to avoid or minimise it. He might find buyers or dealers in the grey market who might be willing to purchase the IPO share at a specific point. If the demand for that particular IPO share is high, he might also make a good profit by selling the IPO before it gets listed. As the transactions are done in cash, the seller can relax and wait for the IPO to get listed.
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If the IPO share opens well and continues to grow, the seller can sell them at a favourable price point. If the shares continue to dip after getting listed, the seller can transfer them to the buyer. In such scenarios, the seller has a definite advantage over the buyer. However, as IPO shares are allocated only to a limited number of bidders, the shares might not actually get allocated to the seller. As a result, the seller will not stand at risk of losing money and the deal that took place in the grey market will be eventually cancelled.
Underwriters are financial experts who need to evaluate the actual value of the IPO. They do it to evaluate the risks carried by businesses and individuals who have invested in it. To get a complete idea of the tentative performance of an IPO share, the underwriters indulge in or monitor grey market trading. It gives them a thorough understanding of how the IPO will be perceived by investors and traders. Therefore, grey market trading is also crucial for underwriters.
Companies often feel the need to test their IPO share before launching it in the market. In such situations, they might introduce their IPO share in the grey market to predict its performance in advance.
IPO applications trading in the grey market
Traders and investors are also keen on trading IPO applications in the grey market. Trading an IPO application is a process where a seller who has applied for an IPO trades the IPO application before it gets allocated to him. As all the applications are treated equally, buying IPO applications is one way of increasing the possibility of share allotment. Trading IPO applications after the allocation of shares is pointless as it would be more meaningful to trade shares at this point in time.
IPO applications trading in the grey market is not supported or regulated by SEBI. Therefore, the buyer only has to trust the seller and hope that he transfers the shares after allotment irrespective of whether its price increases or decreases after getting listed.
The premium price at which an IPO application is being bought or sold in the grey market is referred to as Kostak. The Kostak rate refers to the amount that an IPO bidder makes by selling his application before the allotment of the shares. For instance, if a trader does not want to keep the IPO shares after allotment, he will sell the IPO application in the grey market. The buyer will subscribe to the IPO on behalf of the seller and pay a specific amount to the seller in return. This amount is called Kostak and the profit made through this trading activity is called the Kostak rate.
The Kostak rate ensures that the seller will make a profit irrespective of whether the stock gains or loses money after getting listed in the stock market.
Frequently Asked Questions
1. What happens when an IPO booking is oversubscribed?
An oversubscribed IPO means that more bidders are interested in buying the IPO shares. In such situations, only one lot is allocated to every investor who gets selected in the bidding process. The remaining shares are distributed in a proportionate manner to the investors. The company can also offer more shares to raise more capital. The company may also increase the price of the shares to collect higher capital.
2. Does oversubscription mean more gains for the stock after listing?
Though the oversubscription of an IPO indicates a positive perception and demand for a particular IPO, it does not always result in an increase in the price gains after the stock gets listed. Every investor has different objectives behind purchasing an IPO. The price of the stock can fall or rise on the listing day depending upon whether there is a heavy buying or heavy selling sentiment amongst the investors.
3. What is a grey market IPO?
A grey market IPO is an unofficial market where buying and selling of IPO shares take place. These activities are carried out before the IPO allocation or listing day. While it presents an opportunity for investors to buy an IPO that is in great demand, it is not backed by SEBI or any of the Indian stock exchanges. Therefore, it is not legal to engage in grey market trading.
4. Why is the grey market referred to as the OTC market?
The grey market is referred to as OTC or over-the-counter market as the trading takes place without any participation of the stock exchange. As a result, the shares are directly handed over by traders and brokers without any legal backing or framework. It is similar to the grey market where electronic devices and equipment are exported from other countries where they are available at cheaper prices. However, these exported goods do not match the local safety standards.
5. What is the difference between a black market and a grey market?
A black market is where illegal activities are rampant without any restrictions. While the grey market does not operate through a legal framework, it does not involve any illegal activity. In fact, the trading activities that are carried out in a grey market are based on mutual trust and confidence. Therefore, it is a lot safer than a black market which includes activities that affect the economy and include tax evasion as well.
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