What is Grey Market Premium & How It Affects IPO Pricing?

Capital markets are a place for price discovery. While transactions and prices in the capital market are official and regulated, there is also an informal and unregulated market for deals between known parties.

These informal deals between known parties, usually mediated by a broker, take place in what is called the Grey Market.

What is the Grey Market and How Does it Work?

The grey market is an unofficial market where company shares are traded before they are officially listed on the stock exchange. It is often called a “parallel market” because it runs outside the formal trading system. Trading in the grey market is neither illegal nor officially recognised, but it operates completely on trust between buyers, sellers, and brokers.

In the case of an IPO grey market, shares of a company that has announced its IPO are bought and sold unofficially. Investors use this market to understand how much demand there is for an IPO and to estimate its potential listing price. Since these transactions are unregulated, they come with higher risk but also provide an early opportunity for investors who missed applying in the IPO.

Understanding Grey Market in India

In the world of stocks, the grey market is a stage where transactions of unlisted stocks occur without an official exchange. Employees of unlisted companies often sell shares received under the Employee Stock Option Plan (ESOP) via such transactions. Some promoters, too, sell a stake in their company through such deals.

The grey market is not an illegal market, but there is no legal recourse. This unregulated marketplace serves as a testing ground for companies to assess the demand for their impending IPO and to estimate a suitable valuation.

Without the watchful eyes of an official exchange, the grey market operates on the currency of trust. As there is no recourse to a sour deal, the grey market is meant for investors with a high-risk appetite.

Grey Market and IPOs

The grey market dons the hat of a weather vane during the initial public offering (IPO) process. It's often used as a litmus test to gauge the demand for an IPO and to determine its valuation before it hits the official exchange.

Investors closely monitor the grey market trends to make decisions about IPO participation.

The grey market presents an excellent opportunity for retail investors and traders to purchase shares before they are listed. It also provides an exit route for customers wanting to offload their IPO shares before listing.

What is Grey Market Stock?

A grey market stock refers to shares of a company that are traded before the company’s IPO is listed on the stock exchange. This trading happens without SEBI’s supervision, and no official rules govern it. Deals are made directly between investors through grey market dealers, with prices set on mutual agreement.

For example, suppose a company plans to issue shares at ₹2000 in its IPO. If investors are willing to buy them at ₹2500 in the grey market, this indicates strong demand and suggests a higher listing price. On the other hand, if the stock trades at ₹1800, it shows weaker demand. Grey market stocks give an unofficial but useful signal about investor sentiment.

What is Grey Market Premium?

The grey market premium (GMP) is the additional price investors are willing to pay for IPO shares in the grey market before the official listing. GMP reflects the expected performance of a stock once it lists.

If the GMP is positive, it means investors are bullish (hopeful) and expect the stock to list higher than the issue price.
If the GMP is negative, it means investors are bearish (cautious) and expect the stock to list below the issue price.

For instance, if a company fixes its IPO price at ₹100 and the GMP IPO is ₹50, investors believe the stock may list at around ₹150. While GMP is a popular indicator, it is not always accurate as it depends on demand, supply, and market conditions.

If the grey market premium (GMP) is high, investors believe the stock will perform well after it is listed.

If the premium is low or negative, investors are concerned about the share's performance after it is listed.

By analysing GMP, you can easily predict how the stock will perform on the day it is listed.

One thing to keep in mind is that GMP is not always consistent. It varies according to the supply and demand for shares. Also, the prevailing market sentiment has a significant impact on premium prices.

Types of Trading in the Grey Market

In the grey market, two types of trading are most common:

1. Stock Trading

This involves buying and selling IPO shares before they are listed. Prices are decided between the buyer and seller, often influenced by the current IPO grey market premium. Once the shares are officially allotted, they are transferred to the buyer’s demat account.

2. Application Trading (Kostak)

This type of trading involves buying and selling IPO applications instead of shares. Here, a buyer pays a fixed amount, called the Kostak rate, to the seller for the right to own the shares if they are allotted. Unlike GMP, which changes daily, Kostak is usually a fixed price agreed upon by both parties.

Both methods involve risk because trades are unregulated and depend solely on trust.

Steps to Trade IPO Shares in the Grey Market

If you are considering trading IPO shares in the grey market IPO, here’s the step-by-step process:

Choose the IPO – Decide which company’s IPO you want to buy shares in. Study its financial reports, such as balance sheet, profit and loss statement, and cash flow statement.
Keep Demat Account Active – Ensure your demat account is active and ready to receive shares once the deal is finalised.
Fix a Budget – Decide how much money you are willing to spend and how many shares you want to purchase.
Find a Trusted Dealer or Seller – Since the grey market is unregulated, finding a genuine broker or seller is crucial.
Negotiate Price – The deal price is usually based on the current grey market premium (GMP IPO) and demand for the shares.
Share Your Demat Details – Provide your CMR copy (Client Master Report) with details like PAN number, client ID, and demat number for the transfer.
Transfer Funds and Receive Shares – Once you transfer the agreed payment, the seller initiates the transaction, and the shares are credited to your demat account, usually within 4–12 working hours.

Caution: Since the grey market is unofficial, there is no legal recourse if things go wrong. Always trade carefully and only with trusted and genuine sellers.

Conclusion

The Grey Market is not for everybody, especially novices. Risk-averse investors must stay away from this market as there is no way to settle differences that arise from a transaction.

It is your hard-earned money. Follow an asset allocation strategy to generate wealth. Engage the services of a SEBI-registered investment adviser in case you need guidance on investing.

Must Read - Types of Capital Markets

Frequently Asked Questions

1. What variables determine the price of an initial public offering (IPO) on the grey market?

The price of an IPO in the grey market is mainly decided by the demand and supply of shares before listing. If more investors want to buy shares, the price or grey market premium rises. Other factors include company fundamentals, overall stock market sentiment, and expected listing gains. Since this market is unregulated, prices vary daily and depend entirely on investor confidence and broker negotiations.

2. How to Calculate Grey Market Premium?

To calculate the grey market premium (GMP IPO), subtract the official IPO issue price from the grey market trading price. For example, if an IPO share is priced at ₹100 officially and is trading at ₹150 in the grey market, the GMP is ₹50. A positive GMP shows high investor demand, while a negative GMP indicates weak sentiment and possible lower listing price.

3. What is the Kostak Rate?

The Kostak rate is the price at which IPO applications are traded in the grey market IPO before allotment. Instead of shares, investors buy or sell the right to an IPO application at a fixed cost. For example, if the Kostak rate is ₹800, it means the buyer pays ₹800 to the seller regardless of whether shares are allotted. Unlike GMP, Kostak rates are usually fixed and based on demand.

4. How does GMP affect IPO listing price?

The grey market premium acts as an indicator of the possible IPO listing price. A high GMP suggests that investors expect the stock to list above the issue price, while a low or negative GMP reflects weak demand and fear of a poor listing. However, GMP is only unofficial and not always accurate. Final listing prices also depend on company performance, market conditions, and overall investor sentiment on listing day.