Understanding the IPO Grey Market: How It Works & Know the Risks

The IPO grey market is a lesser-known segment of the Indian stock ecosystem that continues to intrigue retail investors. While it operates outside regulatory oversight, it often sets the tone for investor sentiment even before shares are officially listed. This guide explains how the IPO grey market functions, its main components, and the inherent risks associated with participating in it.

The IPO grey market refers to the informal market where shares of an upcoming Initial Public Offering (IPO) are bought and sold before their official listing on the stock exchange. It operates outside the jurisdiction of regulatory bodies like the Securities and Exchange Board of India (SEBI), which means it is unregulated and largely trust-based.

In the grey market, transactions occur through dealers or brokers who act as intermediaries between buyers and sellers. It primarily involves the trading of IPO applications or shares at a premium (or discount) known as the Grey Market Premium (GMP).

Understanding the grey market requires familiarity with three core components:

Grey Market Premium (GMP)

The GMP indicates how much above or below the issue price the IPO shares are being traded in the grey market. For example, if the IPO price is Rs. 100 and the GMP is Rs. 30, the shares are being traded at Rs. 130 in the grey market.

GMP Formula:
Grey Market Price = IPO Issue Price + Grey Market Premium

While GMP can be a signal of market sentiment, it is not always a reliable predictor of the actual listing price.

Kostak Rate

The Kostak rate refers to the price at which an entire IPO application is bought and sold in the grey market, regardless of the number of shares allotted. This rate is typically relevant when the IPO is oversubscribed.

Example: If someone sells their IPO application for Rs. 1,000 at the Kostak rate, the buyer is entitled to the allotment and any subsequent gains or losses.

Subject to Sauda

This is an agreement to sell the application only if the shares are allotted. It involves a conditional deal based on allotment success. The buyer pays a fixed premium if the shares are allotted; otherwise, the deal is null.

Example: A Subject to Sauda rate of Rs. 4,000 means the buyer pays Rs. 4,000 only if the shares are allotted.

The grey market in India operates through an informal network of dealers and brokers. Here's how it typically works:

1. IPO Announcement: When a company announces an IPO, interested parties assess the fundamentals and begin speculating on demand.
   

2. Dealer Networks: Brokers or dealers act as intermediaries, connecting buyers and sellers of IPO applications or shares.
   

3. Determining GMP and Kostak Rates: These are driven by perceived demand and company reputation. Rates are not fixed and change based on investor sentiment and external market conditions.
   

4. Settlement Process: Transactions in the grey market are cash-based and occur off the books. Trust and long-standing relationships form the foundation of these deals.
   

While the grey market offers a glimpse into investor sentiment, it comes with significant risks:

Lack of Regulation

As the grey market is not under SEBI's purview, there is no regulatory protection for investors. Disputes or defaults cannot be legally enforced.

Price Volatility

GMPs can fluctuate wildly based on market rumours, macroeconomic trends, or sudden changes in company outlook.

Legal Implications

Trading in the grey market isn't technically illegal, but it's not officially recognised either. Investors participating in it do so at their own risk.

Fraud and Default Risks

Since deals are unregulated and conducted in cash, the risk of default or fraud is significant. If a broker defaults, the investor has little to no recourse.

SEBI has consistently warned investors about unregulated platforms and markets. It emphasises transparency and regulatory compliance in primary market investments. While SEBI does not directly regulate the grey market, its role becomes critical in safeguarding retail investors through educational campaigns and stricter oversight of IPO disclosures.

Some brokerage firms have internal guidelines prohibiting employees and affiliates from participating in grey market dealings due to its non-compliant nature.

Example 1: High GMP but Low Listing

An IPO from Company A had a GMP of Rs. 80, but it listed at just Rs. 30 above the issue price. Many retail investors who relied on the GMP suffered losses due to overestimation.

Example 2: Accurate GMP Prediction

Company B showed a GMP of Rs. 50. It eventually listed at a Rs. 55 premium, closely matching grey market expectations. Though rare, there are instances where GMP has aligned with listing price — however, this should not be considered a reliable indicator.

Example 3: Kostak Deal Gone Wrong

An investor sold an application for Rs. 2,000 Kostak, but the IPO was underwhelming. The buyer couldn't recover their cost, highlighting the risk in trusting demand speculation.

Engaging in the grey market is akin to speculative trading with limited safety nets. For seasoned market participants, it might offer a quick insight into market sentiment, but for most retail investors, it presents more risks than rewards.

• Pros:
  

  • Early indication of demand
    

  • Potential for gains if predictions hold
    

• Cons:
  

  • High volatility
    

  • No legal protection
    

  • Prone to misinformation and default
    

The grey market should not form the basis of your investment decision. Investors should be aware that the grey market is speculative, lacks transparency, and offers no regulatory protection or legal recourse. Instead, investors should rely on company fundamentals, official disclosures, and SEBI-approved research.

The IPO grey market, while offering early insights into investor interest, remains an unofficial and risky avenue. Retail investors should approach it with caution, prioritising regulated investment channels and due diligence over speculative trading. Understanding its working and inherent risks is essential for anyone curious about IPO pricing dynamics and market sentiment.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

1. SEBI Official Website
   

2. Moneycontrol IPO Grey Market Tracker
   

3. Economic Times - IPO Section
   

4. Livemint Business News
   

5. Groww IPO Grey Market Guide
   

6. Zerodha Varsity
   

7. Angel One Blog on IPO Grey Market