Grey Market IPOs: Introductions, Explanations, and the Essential How-to’s

What Is the Grey Market?

For the large majority of people, the world exists on a black and white paradigm. One side is everything right, and the other is everything wrong. In reality, the world exists on a spectrum, with as much a grey path as black and white.

And what you need to know is, that the stock market is no different

Grey markets are essentially unofficial markets that aren’t backed by an authority like the Securities Exchange Commission, where users and investors can buy upcoming IPO shares before they are listed on secondary markets. This OTC market remains largely unregulated and unsupervised today, with most transactions conducted through hard cash.

What Are Grey Market IPOs?

As you might have guessed by now, grey market IPOs are IPOs offered on the grey market, with no government agency supervising the trading of IPO shares. In most cases, these Initial Public Offerings happen between a small group of people, as there is no third party (like a stock broker) to draw attention to the new upcoming IPO. This allows investors to get in on the action early, as well as get a feel for the company’s path after the IPO launches on the secondary markets.

Is the Grey Market An Official Part of the IPO Market?

The short answer is no.

The IPO market is a registered, supervised, and official medium of raising funds in the present market under the supervision of regulatory agencies. The grey market, on the other hand, is both unrecognized, unofficial, and unsupervised, which means it doesn’t come with the protections against fraud the IPO market comes with.

When dealing with grey market IPOs, there are two terms you’re going to be seeing often: Kostak and Premium. Both of them refer to different ways in which individuals interact with the grey market IPOs.

What Are Kostak Rates?

Kostak rates are a little complicated to understand for a beginner. Essentially, Kostak rates are the cases where an investor pays for the IPO application before the listing happens. IPO applications on Kostak rates happen outside the regulated market, and allow investors to fix their profits.

The catch is that Kostak rates apply to any condition you get your allotment in.

For example, if you filed 5 applications for a particular IPO and sold them at 1000 each, you secured profits from the IPO at 5000. But, and this is the interesting part, if you filed two allotments, your profit will still be the same. If you sell your stock from the IPO above a certain specified amount, you’ll need to give the remaining profit to the person who bought the application for you.

What Are Premium Rates?

Most commonly called Grey Market Premium Rates, these rates are a premium amount at which the IPO’s stocks are traded before being listed in secondary markets like stock exchanges.

The Grey Market Premium also reflects how the IPO will look on the official listing day.

For example, if a company introduces an IPO on the grey market for 80, and the grey market premium is around 20, then one can expect the IPO to list for 100 on listing day. This isn’t a 100% reliable way of predicting the price on listing day, but the consensus remains that it’s a must-know for investors looking to get in on the action early.

How Does the Grey Market Work?

Here’s a simple breakdown of how IPO shares are bought and sold on the grey market:

1. Sellers apply for shares via an Initial Public Offering. They take a significant risk here, as they may not have any shares allocated to them.
2. Buyers place orders to buy these IPO shares through grey market dealers.
3. These dealers contact the seller about their willingness to sell. The seller can either sell directly to the grey market dealer himself or send the application details to a buyer through the dealer.
4. The buyer is then notified that he has bought several shares through the grey market.
5. The next step depends on whether any shares are allocated to the sellers. If some are allocated, the seller either transfers them to a Demat trading account or sells them directly to the dealer.
6. If the seller wants to sell their shares, the settlement happens to depend on the profit or loss made, factoring in the grey market premium at which the deal was made.
7. If no shares are allocated to the seller, the deal is considered null and void.

The Takeaway

When everything’s said and done, you need to keep a few things in mind. You do have to pay a short-term capital gain tax on your profits made by selling shares on the grey market. You should also know that while it’s made out to be a big deal, grey market trading happens on a number of different trading apps where it’s loosely supervised by the company operating the app.

(Above mentioned article is consumer connect initiative. This article is a paid publication and does not have journalistic/editorial involvement of IDPL, and IDPL claims no responsibility whatsoever.)