Decoding GMP in IPOs: Inside GMP Operators and the Kostak Mystery
But what exactly is this grey market premium, and how does it influence investment decisions?
In the world of stock markets, where investors are constantly on the lookout for opportunities to maximize their gains, the grey market premium (GMP) has emerged as a crucial metric to consider before diving into an Initial Public Offering (IPO). But what exactly is this grey market premium, and how does it influence investment decisions? In this blog post, we'll take you on a journey through the colorful landscape of IPOs and the intriguing world of grey market premiums.
Understanding Grey Market Premium (GMP)
To grasp the concept of grey market premiums, let's start with a relatable example. Imagine a highly-anticipated smartphone about to be launched by a renowned company, which we'll call "TechCorp." Before the official release date, a handful of sellers manage to get their hands on this smartphone through unofficial channels. These sellers are not authorized by TechCorp to sell the phone, but they offer it in the grey market.
Official Price: TechCorp announces that the official price of the new smartphone is Rs 50,000.
Grey Market Price: In the grey market, where the phone is not officially available yet, early sellers start offering the same phone for Rs 60,000, which is Rs 10,000 more than the official price.
Grey Market Premium: The grey market premium, in this case, is the additional Rs 10,000 that buyers are willing to pay to get the phone before it's officially released. It's essentially the premium or extra cost associated with buying the phone early from unofficial sources.
In simpler terms, the grey market premium is the extra amount of money people are willing to pay to get a product before its official release or when it's not available through authorized channels. It reflects the demand for the product and the willingness of buyers to pay more for early access. However, it's important to note that grey market purchases come with certain risks, such as lack of warranty and potential legal issues, so buyers should exercise caution when considering them.
Ten Fascinating Facts About Grey Market Premium
Unofficial Primary Market: The grey market operates as an unofficial market for IPOs, also known as the primary market.
Not Just IPO Shares: Grey market premiums apply not only to IPO shares before they are listed but also to the IPO application itself.
Kostak Rate: Kostak rate refers to the predetermined price at which one is willing to sell the IPO application, typically in the retail category, in the grey market.
No Official Rules: The pre-IPO grey market is unofficial, meaning it lacks rules and regulations to govern its operations.
Cash Transactions: All transactions in the IPO grey market are conducted in cash.
Trust-Based Transactions: Grey market deals rely on trust, often sealed with small slips of paper serving as informal contracts.
Forward Market: Similar to a forward market, grey market transactions leave room for default by one party.
No Official Dealers: Unlike traditional stock exchanges, there are no official dealers in the grey market; all transactions occur through word-of-mouth.
Premium Indicator: A higher grey market premium for an IPO often indicates a higher likelihood of it being listed at a significant price on the stock exchanges.
Early Activity: Grey market activity can commence well before the official announcement of IPO price bands.
Deciphering Grey Market Premium in IPOs
For IPO-bound companies, the term "grey" refers to the "grey market premium." This unofficial market operates in the primary or IPO market space. Here, shares from the IPO are bought and sold before their official listing on stock exchanges. The pricing in this pre-IPO market is determined by certain parties, and because it's unofficial, transactions are conducted solely in cash and on a personal basis. The grey market operates on trust, without written contracts or applications. If something goes wrong, there's no regulatory authority or official backing to turn to. Despite its risks, the grey market thrives.
The grey market premium serves as a direct indicator of a stock's post-listing performance. It's not just about premiums on IPO shares; it also encompasses the premiums on IPO applications.
How Grey Markets Function: A Case Study
Now, let's unravel the inner workings of grey markets for IPO shares. Suppose Mr. ABC applies for an IPO in the retail category with an application of up to Rs. 2 lakh. He understands that he might not receive any allocated shares or that the stock may be listed at a discount. Nonetheless, he decides to take a calculated risk.
On the other side, we have Mr. XYZ, who is highly confident in the prospects of the IPO company and wants to secure an assured allotment without going through the IPO process. Mr. XYZ contacts a grey market dealer through informal channels, and the agent assures Mr. XYZ of getting him the allocated shares. The agent acts as an intermediary, negotiating a perceived premium price for the IPO shares. Mr. ABC is informed that there is a buyer ready if he is willing to sell upon receiving the allotment. Mr. ABC is guaranteed a premium of Rs. 50 per share over the IPO price, regardless of the listing price. Mr. ABC agrees, and the agent records his IPO application details, which are then shared with Mr. XYZ.
On the listing day, when Mr. ABC receives the allotted shares, the agent advises him to sell the shares, and Mr. B purchases them at the agreed price (IPO price + Rs. 50). If the listing price is higher than this price, Mr. XYZ makes a profit, and vice versa.
Understanding Kostak: The Predetermined Price
Now, let's shift our focus to the grey market for IPO applications, often referred to as "kostak." The kostak rate represents the predetermined price in the grey market at which one is willing to sell an IPO application. Here, the perception and hype generated for the IPO directly impact the kostak and the grey market premium for the shares.
To illustrate, let's return to our previous example. Suppose there is a bid from a grey market agent (Mr. XYZ) to buy Mr. ABC's IPO application. Assume the upper end of the IPO price band is Rs. 225, with a minimum lot size of 65. The quoted kostak price is Rs. 700, while the grey market premium (GMP) stands at Rs. 40. If Mr. ABC sells his application to Mr. XYZ, Mr. XYZ will have to pay Rs. 700 to Mr. ABC.
Now, if the stock is listed at Rs. 300, which is Rs. 75 higher than the IPO price, the net gain for Mr. ABC would be Rs. 4,875, assuming he is allotted 65 shares. However, the kostak price was set at Rs. 700. In this scenario, Mr. ABC retains only Rs. 700 and gives Rs. 4,175 to Mr. XYZ.
Conversely, if the stock had been listed well below the IPO price or if Mr. ABC had not been allotted any shares, he would have been the one benefiting.
Finding a Grey Market Dealer
Now you might be wondering how to contact a grey market dealer. Unlike the official offices and registered brokers on Dalal Street, BSE, and NSE, grey market deals have no specific location. It operates unofficially, relying solely on trust.
The network of individuals engaged in these clandestine transactions thrives on word-of-mouth. Given its unofficial nature, dealers are cautious about unfamiliar faces or those not "introduced" to them. If you wish to engage in a grey market deal, you'll need to navigate the market, talk to various individuals, and eventually establish trust to be "introduced" to a dealer.
The Dark Side: Grey Market Manipulations
Grey markets are notorious for being a major instrument of price manipulation. There have been instances where stocks were listed at staggering prices, only to plummet shortly after. This manipulation often leaves small investors in a precarious position.
But who are the actors in this manipulation? Grey market trades are predominantly orchestrated by High Net Worth Individuals (HNIs), who make significant applications in the HNI category of IPOs. The so-called operators acquire shares in the grey market. On the listing day, these operators purchase a substantial quantity from the open market as well, essentially securing the entire allotment in the HNI category and a portion of the Retail category.
In some cases, gullible investors are lured by listing prices and influenced by "technical experts" who recommend buying these stocks. While this practice may not be illegal, it erodes market confidence and transforms the stock market into something akin to a casino.
A Word of Caution: Grey Market Operations
In conclusion, we urge all investors to exercise caution when considering grey market premiums as indicators of an IPO's success or failure. A fundamentally strong company, backed by a robust promoter and reasonably priced, is likely to receive overwhelming subscription. Therefore, it's crucial to focus on the project, the business model, and the IPO's objectives. Kostak and grey market premiums provide valuable insights, but they are not infallible indicators. Ultimately, it's better to stay clear of the grey market to avoid potential losses and ensure peaceful nights without the worry of falling prey to powerful manipulators. Remember, it's the small investor who often bears the brunt of such deals, while the powerful thrive.