What is IPO GMP?

What is IPO GMP?

When a company decides to go public through an Initial Public Offering (IPO), investors eagerly await the stock's official debut on the stock exchange. But even before the stock is listed, there’s a buzz in the market- cut to; the grey market. This unofficial space allows traders to buy and sell shares of an IPO before it’s listed, and one key term that dominates these conversations is GMP, or Grey Market Premium. In this article, we’ll delve into the intriguing world of the grey market, explore how it operates, and uncover how IPOs and GMP influence each other. 
 

What is the Grey Market?

The grey market is an informal market where stocks or IPO applications are bought and sold before they are officially listed on the stock exchanges. Unlike the formal markets, where stocks are traded through registered exchanges like the BSE or NSE and are regulated by bodies like SEBI, the grey market operates outside the official purview. The value of GMP changes on a daily basis based on stock demand. IPO-bound firms test waters in the grey market before making the listing debut, and the GMP acts as a key indicator. This market is heavily reliant on trust between buyers and sellers, as there are no formal contracts or oversight. Hence, trading in the grey market also comes with a lot of risk. 
In the context of IPOs, grey market trading generally involves two activities:

• Trading IPO shares pre-listing: Investors can buy or sell IPO shares before the company officially lists its shares on the stock exchanges. This allows traders to speculate on the performance of the stock based on early interest or market sentiment. If demand for the IPO is high, the price in the grey market could be higher than the offer price, reflecting a premium (the Grey Market Premium, or GMP). If interest is low, the grey market price might be below the offer price.
• Trading IPO applications: Investors can also trade IPO application forms in the grey market, sometimes at a premium or discount based on the anticipated success of the IPO. This allows individuals who may have missed the opportunity to apply for the IPO in the official market to still gain exposure by purchasing application forms from others willing to sell them.

Stock exchanges, SEBI, and brokers don’t have any involvement or back any transactions taking place in the grey market. While this market offers an early indication of the stock’s potential, it is important to remember that it is highly unregulated. Therefore, it comes with inherent risks. As a result, investors are advised to exercise caution when participating in the grey market and carefully assess the risks before making any trades.

What is Grey Market Stock?

Unofficially traded corporate shares are referred to as gray market stocks. Grey market stocks are those that are offered by dealers prior to a company's formal initial public offering (IPO). The gray market stock is often operated by a small group of people, and transactions are predicated on their mutual confidence.

What is Grey Market Premium?

The grey market premium is the price at which the grey market's initial public offerings (IPO) shares are traded.  The shares of the company that will be the subject of the initial public offering (IPO) is purchased and sold outside of the stock market.  How the IPO will respond on the day of listing is reflected in the live grey market premium.

For example, if the issue price of a stock is ₹700 and grey market investors are willing to pay ₹950, then the GMP will be ₹150.

Essentially, GMP acts as a measure for the market's sentiment toward an upcoming IPO. When shares of an IPO are traded at a premium in the grey market, it indicates that the market expects the stock to list at a higher price on the exchange than its issue price. 

A higher GMP indicates strong demand for the shares, signaling that the stock may list at a premium, whereas a lower GMP suggests weaker investor sentiment. However, while GMP is a useful predictor, it is important to note that there is no guarantee the actual listing price will match the grey market expectation. The grey market operates informally and is not regulated by SEBI, meaning it reflects market sentiment rather than an assured performance.

How is GMP in IPO Calculated?

Calculating the Grey Market Premium (GMP) involves comparing the price at which IPO shares are traded in the grey market with the official issue price set by the company. The formula for calculating GMPR is straightforward:

GMPR = Gray Market Premium * Number of shares 

Let’s break down the calculation process of IPO GMPR with an example:

• Gather Information: Start by collecting details about the IPO, such as the issue price and the number of shares being offered. Simultaneously, track the prevailing GMP for the same IPO in the grey market.
• Determine the GMP: For example, if the issue price of an IPO is ₹350, and the grey market price is ₹352, then the GMP would be ₹2. If the grey market price exceeds the issue price, it indicates that the stock is trading at a premium due to higher demand.
• Calculate GMP Percentage: Divide the GMP by the issue price, then multiply the result by 100 to get the GMP as a percentage. For example, the GMP percentage would be (4 / 10) × 100 = 40% if the GMP was ₹4 and the issue price was ₹10. This percentage illustrates the difference between the official price and the amount that investors are willing to pay on the black market.

GMP acts as a key indicator of the demand for an IPO. A high GMP reflects strong demand, suggesting that the IPO may perform well after listing. However, since the grey market operates outside the formal exchanges, it is essential to remember that GMP is not a foolproof predictor of IPO performance. It simply represents market sentiment, which can fluctuate and may not accurately reflect the stock's behavior once it officially starts trading on the stock exchanges.

Kostak Rate

The Kostak Rate is another critical term in the grey market. It refers to a mutually agreed price for an entire IPO application, regardless of allotment status. Following are a few key features of the Kostak Rate:

• The buyer agrees to pay the seller a fixed amount for the IPO application, irrespective of whether shares are allotted.
• The Kostak Price applies to the entire application, not on a per-share basis.
• This mechanism protects sellers from allotment risk, as the payment is guaranteed at the agreed rate.

For Example, if the Kostak rate for an IPO application is ₹1,000, a seller who applies for shares will receive ₹1,000 from the buyer, even if they are not allotted any shares.

Subject to Sauda

Subject to Sauda is an extended version of the Kostak rate, but with a significant difference: payment depends on confirmed allotment. Key features of Subject of Sauda are: 

• The buyer agrees to pay a pre-determined amount only if the seller receives a share allotment.
• This conditional payment structure adds flexibility and reduces risk for the buyer.
• Subject to Sauda rates are typically higher than Kostak rates because of the allotment-dependent nature of the transaction.

For example, if an IPO application is priced at ₹1,500 under Subject to Sauda, the buyer will pay this amount only if the seller receives shares in the allotment.

Associated Risk & Challenges

Investors should be aware of certain risks associated with grey market trading:

Lack of Regulation: The grey market operates outside official frameworks, making the information unreliable and prone to inaccuracies.

Volatility: Grey market prices can fluctuate significantly and may not reflect the stock's actual trading price post-listing.

Allotment Uncertainty: A high grey market premium suggests demand but doesn’t guarantee share allotment, as factors like oversubscription and allocation methods play a role.

Overvaluation Risk: Relying solely on grey market premiums can lead to overestimating an IPO's value. Assess the company’s fundamentals, industry trends, and market conditions to make informed decisions.

Liquidity Challenges: Trading in the grey market can be less straightforward than official exchanges, with limited options for exiting or liquidating positions.

Legal Risks: Participating in grey market trading may violate local laws or regulations in some jurisdictions. Be aware of legal implications before engaging.

Conclusion

Understanding IPO GMP and the grey market offers valuable insights into market sentiment and listing-day expectations. While GMP can serve as an early indicator of investor enthusiasm, it’s crucial to approach grey market trading with caution due to its unregulated nature and inherent risks. Investors should combine grey market insights with a thorough analysis of the company’s fundamentals, industry trends, and official market conditions to make informed decisions. Always exercise prudence and prioritize legal and ethical practices when exploring grey market opportunities.