What is Grey Market Price
Even before an Initial Public Offering is raised, a company’s shares are traded unofficially in a grey market at the grey market price (GMP). Unlike the Indian capital markets that are regulated by the Securities Exchange Board of India (Sebi), the grey market has no regulator. Hence, there are no rules or regulations governing this domain. This market is run by a small group of people and all the trades are based on mutual trust.
Grey Market Price
The grey market is scrutinized by investors to understand the demand for a new issue before it is listed in the official markets. This will help the investor determine the price of the share when it is officially listed. The price at which the share trades in this market is called the grey market price.
Grey Market Premium
Let us assume that a company called ABC Ltd has its IPO in a week. You have placed a bid for 1000 shares at an issue price of Rs. 150 per share. Meanwhile, there are other buyers in the grey market who think that the value could be Rs. 250 per share., and are ready to pay the price. So, the grey market premium is Rs.100 per share. (250-150).
The predetermined price paid in the grey market for a share is called the Kostak rate. If you think that the shares of ABC Ltd will fall lower than the grey market price of Rs.250, or lower than the issue price of Rs. 150, you can sell all your shares of ABC Ltd at Rs.250 per share in the unofficial market. You could earn a profit of Rs.1,00,000 (250-150*1000). You can fix the rate outside the market and sell your shares after the IPO. This deal cannot be settled until the day of the IPO. If no shares are allotted to you in the IPO and the share price is quoted lower than the grey market price, then the buyer in the grey market has to pay the difference in these prices to you. If the listed price quoted is more than the grey market price, then you have to pay the difference to the buyer.
Additional Read: What to do when the market falls?
The grey market is unofficial for the reason that it is a huge gamble. You never know how the market would react on the day the shares are listed. You might end up making a profit or suffering a huge losses.
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