01 May 2022

What is Grey Market Premium, KOSTAK rate and Subject to Sauda (or SS rate) | How Grey Market works!


Like there is a Surface Web on the Internet which we all access, such as sites like Google, Facebook, Yahoo, etc. and there is also a dark web here. Which only a few people access. Generally to carry out their illegal activities.

In the same way, there is another market growing under the shadow of the stock market, and only a few people access it. This is called the gray market. In this article you will know, 1st what is gray market and how it works?, 2nd what is the gray market premium?, 3rd what is KOSTAK rate?, and 4th what is subject to Sauda?

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When we talk about the market, there is a White market, where everything is legal and safe. The second is the Black market where everything is illegal and unsafe. Now if we start mixing white and black colors, gray color will come out of it. The Gray market is that form of stock market which is legal like the white market, but at the same time unsafe like the black market.

Legal because shares are bought or sold here, just like in the stock market, and technically these are not illegal activities. Unsafe because here all the contracts are unregulated. The Securities Exchange Board of India (SEBI) does not regulate these markets.

And therefore if someone breaches his contract, then there will be no support against him from the government, police, or the court. Now here, with whom such frauds happen, how he has to recover his money, whether he has to quarrel, fight, or forget, only he knows. Here trades take place only on mutual trust.

How Gray Market works:

Before any company gets listed on the exchange, it has to go through a process, which is called IPO. In the IPO, first of all, the public applies to buy shares from the company by giving a certain amount of the total share price. This small amount is called application money. After this, the company allocates the shares over the ratio of those applications, at this time also a small amount is recovered, which is called allotment money, and the rest of the amount is paid by the company by giving some calls, such as first call, second call, final call, or there may be more.

Now the shares bought by the public from the company can be sold on the white market only after the listing of the company's share on NSE or BSE.

But some people want to trade on those shares even before they are listed, and these trades or contracts are executed in the gray market.

Before listing, when the company announces the issue price band, then trading starts on the gray market. Now, just as brokers work as intermediate between buyer and seller in the white market, similarly there is an intermediate between buyers and sellers in the gray market. But it is not necessary to be a qualified broker here. Those who are intermediaries here are called Dealers.

What is Gray Markets Premium (GMP):

The dealer also decides the price of the shares on the gray market, and there is no valid base for this price. Whatever price the dealer feels is right according to his analysis, the same is quoted.

If the company is selling its shares in IPO for ₹ 100, and the dealer in the gray market quotes a price of ₹ 130, then this extra ₹ 30 will be called Gray Market Premium or in short GMP.

Suppose you buy the shares from the company for ₹ 100 and sell them in the gray market for ₹ 130, then you will instantly make a profit of 30 due to the gray market premium. But you will not get any listing gain or loss of those shares. Let's assume the share gets listed for 150 but as you already sold it on the gray market for 130 only, then you have a loss of ₹ 20, and the one who bought those shares from you on the gray market, gets a profit of ₹ 20.

On the other hand, if that stock is listed for ₹ 80, you have made an instant profit of ₹ 30 (₹ 130 - ₹ 100), and you are saved even a loss of ₹ 20. That means, you are in a total profit of ₹ 50, and who bought those stocks from you in the gray market for Rs 130, due to listing of 80, he is in a total loss of ₹ 50.

What is KOSTAK and SS rate (Subject to Sauda):

It is not necessary that the company will allow you as many shares as you applied through IPO. For example, if the company has to sell 100 shares(qty) and the company receives 50 applications. And if each one of them applies for 4 shares(qty), then the company gets a total application of 200 shares(qty). Now the company has to sell only 100 shares(qty), then the company will be able to allow only 2 shares and not 4 to each one. Now GMP is a rate that is applicable after allotment, but even before the allotment takes place, there is a second rate on the application lots, which is called the 'KOSTAK' rate. If the KOSTAK rate is divided by the number of shares in the lot, then this amount will be less than the gray market premium. Because it also includes the risk of not getting allotments, along with the listing loss.

If someone is buying shares from you on the Gray market at a KOSTAK rate, then he/she is only buying your share applications. Not all the shares need to be allotted to him/her by the company. But whether allotment is granted or not, you are already getting the fixed KOSTAK rate on your applications only. So your entire risk will be transferred to the buyer.

But if that buyer wants to buy on the condition, that your application will buy in lots only after allotment, and if the full allotment is not done then the deal will be canceled, then there is a different rate for this type of contract, which is called 'Subject to Sauda' or SS rate. In the SS rate, there is no risk transfer of not having share allotment, that's why the rate of it, is also higher than the KOSTAK rate.

Many people try to estimate the listing price of shares from GMP, but most of the time there is a huge difference between the gray market premium and the listing price. Because the fundamental strength of the company is not reflected in the price from the gray market.