In major cases, before an IPO comes to the market, they are taken to an unofficial market to understand the demand for it. This unofficial market is called grey market.
What is the grey market?
- Financial securities are traded on the gray market, which is an unofficial market. In the gray market, stocks that have been suspended for trading or securities that have not yet been officially listed for trading are usually bought or sold before the market opens officially. Underwriters and issuers can estimate demand for new offerings on the gray market. In the near future, it will offer securities. Despite being unofficial, gray markets are not illegal. As well as gray markets, gray trade involves unauthorized dealers importing and selling goods, which is also unauthorized but not illegal. Alternatively,
- The grey market is parallel market, where the trading of stocks of companies takes place, outside the official trading channel.
- The white market is legal stock market, the black market is an illegal market, and the grey market Stands somewhere in between.
- An IPO grey market is one where the company’s shares are bid and offered by traders unofficially before the shares are issued by the company through an IPO.
- The grey market is unofficial, but not illegal.
- Unlike the stock market, there is no governing body like SEBI.
Why is Grey Market trading done?
With the arrival of any new IPO, trading starts in the gray market. But the question arises that why shares are traded in the gray market?
- The main objective of trading in the gray market is to earn maximum profit by guessing the listing of the company’s shares. If an investor thinks that the value of the company’s stock is going to increase in the future, then he buys the shares even before they are listed on the stock exchange.
- On the other hand, such investors who do not want to bear the risk after the shares are listed, they exit by selling the shares in the gray market before the listing.
- Due to IPO shares being traded in the gray market, investors who have not been able to apply for IPO due to any reason can also buy shares. Additionally, investors who are more optimistic about the future of the company trade in the IPO gray market to buy more shares.
- Underwriters also get information about the valuation of the company through gray market trading. Based on the gray market, underwriters get an idea of the demand for the company’s stocks.
How does it work?
- All transactions in the grey market are done in cash.
- Only a select few traders and investors have access to the market, as there is no official platform or rules defined for this trading.
- It all work based on mutual trust.
There are two main terms in grey market
- Grey Market Premium
- Kostak Rate
Grey Market Premium: Grey market premium (GMP) is a premium amount at which grey market IPO shares are traded before they get listed on the stock exchange.
The GMP shows at what price the IPO might be listed in the stock exchange.
For example: if a company introduces an IPO for ₹ 100 and the GMP is ₹ 20, then we can assume the IPO to list around ₹ 120.
There is no reliability in most cases, the GMP works properly and IPO lists around the given price.
Suppose there are buyer and a seller in the grey market.
When an IPO comes out in the stock market, it is not necessary that everyone who applies will get it.
But in this case, the buyer really wants this IPO allotment. So he decides to make a deal with the seller that if the seller gets the IPO allotment, he will transfer it to the buyer and for that, the buyer pays the seller ₹ 5000 upfront.
Here, buyer takes the risk of ₹ 5000 to get the IPO listing.
Scenario 1: if the seller gets the IPO allotment of say, ₹ 20,000 then he transfers it to the buyer, which means:
Buyer's profit ₹15,000 (₹20,000 – ₹5,000)
Seller's profit = ₹5000 (amt given by the buyer)
Scenario 2: if the seller doesn’t get the IPO allotment:
Buyer's loss = ₹ 5,000 (which he gave to seller)
Sellers profit ₹ 5000 (amt given by the buyer)
So in both cases, the seller has a profit of ₹ 5000, while the buyer takes a risk of either losing ₹5000 or gaining 3x, which is ₹15000.
Can there be negative gray market premiums?
The gray market premium of an IPO can be positive or negative. Assuming the price of one share of an IPO is 100, and the market trend is downward for that IPO. Because of this, grey market sellers are selling more shares of that IPO. A gray market transaction in this case would allow you to purchase these shares for less than the issue price.
Consequently, the shares are trading at negative GMP since they are below the issue price.
What is Subject to Sauda?
Parenthesis rates can also be expressed as subject to Sauda. The IPO application you placed gets sold to anyone in Subject to Sauda for ₹ 1500 per lot. IPO allottees will give you ₹ 1500 each if you are allotted IPO.
For this type of deal to become valid, an allotment of shares is required. The subject to Sauda amount is only paid by the buyer if you are allotted shares in the IPO. In the absence of an allotment, the deal is canceled. In contrast, the buyer pays the cost rate regardless of an allocation.
GMP Risk Factors
- As there are no regulators on the gray market, the most significant risk is that it is unregulated.
- A gray market trade can only be conducted orally and is not written anywhere. In the event that one party breaches its promise, there is no alternative to going anywhere else. There is no way for SEBI to take action in these matters since there is no regulator.
- Premiums on the gray market are unreliable. Dealers or websites may tell you about IPO gray market premiums or GMPs, but their credibility is always in question.
Are there any taxes on selling IPO applications in the gray market?
It is not common knowledge among investors who sell IPO applications on the gray market that they have to pay taxes on those transactions. On profits from these deals, investors must pay STCG (Short Term Capital Gains Tax) at the rate of 15%.
Using this example, you will be able to figure out how much profit you will actually receive after selling the application on the gray market?
- In the following example, let’s say you IPO 150 shares of Zomato for ₹100. At a cost of ₹ 2500, you sold your IPO application.
- Fortunately, you received an IPO allotment. You sold the stock of Zomato for ₹ 30,000 (150×200) at the buyer’s behest. Consequently, you have a profit of ₹15,000 (30,000-15,000).
- A return of ₹ 12,500 to the gray market dealer was equal to ₹2500 for you out of a profit of ₹15000. Accordingly, the tax on this transaction is as follows:
- Out of ₹ 15000, you made ₹2,500 in profits. Taxes will be charged only on the entire amount of ₹15,000.
- You must pay STCG of ₹ 2250 (₹15,000×15%). The actual profit you have is ₹ 250 (2500-2250).
How to sell and buy IPO applications in the gray market?
The gray market is an unofficial market. Gray market transactions are not related to any official person or business. You need to find a local broker if you plan on buying and selling IPO stocks privately. A gray market dealer can facilitate the purchase or sale of shares on the gray market through the use of an intermediary. Buyers and sellers are reconciled by this dealer.
To determine IPO demand, GMP is a suitable indicator. However, due to the nature of the gray market premium, the possibility of manipulation is very high. You must take into consideration all aspects before investing in any IPO as a conscious investor.
Disclaimer: The views expressed in this article are for educational purposes only. Before investing anywhere, be aware of the risks
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