A Surfer's Paradise?

VOLATILITY IS in these days. 'Playing safe' and 'going long-term' play no longer play a role in the modus operandi of the new-age investor in India. The new breed of investors likes to play the market and thrives on taking risks.

While volatility is generally perceived as an indicator of high risk, it can also be used to one's advantage by utilising it to earn returns in a very short span of time. To provide a reckoner on volatility ET Investor's Guide analysed intra-day volatility of BSE 100 stocks over a three-month period from September to November '07. We calculated the daily volatility for 64 trading sessions to arrive at the average volatility. While there are complicated mathematical ways of calculating volatility, a simple method is by looking at the highest and lowest value of the stock. For example, if a stock had a price range of Rs 900-1,100 in a day, then its volatility for the day will be 200 divided by 1,000, the average value, expressed in percentage. Volatility in this particular case will be 20%.

Our analysis shows that Reliance Natural Resources (RNRL) has had the maximum average intra-day volatility of 9.6% during the period, with the highest intra-day volatility of 34%. RNRL is followed by Essar Oil with an average intra-day volatility of 9.4% and the maximum intra-day volatility of 43%. Among the top 10 volatile stocks, four are from the Reliance pack (both groups together) and two from the Indiabulls' stable.

This means that if an investor had taken an exposure of Rs 1,00,000 each in the top 10 volatile stocks at the day's low and sold at the day's high, s/he would have made a total gain of Rs 76,050, or 7.6% of the exposure taken, on an average day. Even if we assume that s/he is able to encash 50% of the total gains available through intra-day volatility, s/he would have made a total gain of Rs 24,33,680 on an exposure of Rs 10,00,000 - a cool 243% of the exposure taken over the three-month period!

If you think capturing even 50% value is too much and requires a lot of skill, settle for 10%. Even that will give you about Rs 5 lakh within three months! There is scope for an even higher risk and better returns than what we have mentioned so far. This is possible in case of intra-day players who take positions to exit them on volatility at a suitable time during the same session, in the futures & options (F&O) segment.

Our analysis revealed that the most volatile stocks are concentrated in the infrastructure-related and financial services sectors, which have also offered high returns even for investors taking deliveries. On the contrary, stocks from sectors like FMCG, pharmaceuticals and information technology - considered to be relatively safe in the market - hardly offer any scope for intra-day volatility. These stocks have also been underperformers in the past few months. Although the sectoral thrust during the past few sessions continues, the future may not be a replica of the past. There is always a shift in focus in terms of stocks/sectors from time to time in what is popularly called rotation. For an investor who's trying to encash intra-day volatility, the real art lies in being aware of the changing dynamics of the market. On top of a strong sectoral trend, there is a 72% correlation between volatility and the overall appreciation in stocks, which is substantial. This means that if a stock is running up fast, or is expected to outperform the market, there is a 72% chance that it will be volatile.

The analysis also suggests that over the past three months, mid-cap stocks have taken over from the front-runners in hogging the limelight. A major reason for this is that most mid-cap stocks among BSE 100 already figure in the F&O segment and hence, the action in the F&O segment on such counters, particularly those with a large lot size, offers a high degree of volatility on many days. Another conclusion that can be drawn from the analysis is that there is greater volatility in case of stocks already traded in the F&O segment. Apart from BSE 100 companies, mid caps also have a high degree of volatility due to increasing demand. ET Investor's Guide takes a look at the specific factors for some of the most volatile stocks:

RELIANCE NATURAL RESOURCES

There have been no fundamental changes in RNRL's business line. There is talk of restructuring within the group. The volatility in the stock has been at its peak in the past three months since mid-cap stocks from the F&O segment, with a large lot size, have seen wild swings due to heavy participation from retail investors and market operators. In case of RNRL, the lot size is high at 7,150 shares for each contract, taking the value of every lot from Rs 3.6 lakh in early September, to four times its value at the end of November.

ESSAR OIL

The stock got re-rated two months ago after its peer, Reliance Petroleum - whose refinery is yet to be commissioned - surged significantly. The promoters' commitment to infuse further funds in the company also awakened a positive response. In this case, too, the lot size of stock in the F&O segment is significantly high at 5,650 shares. The trajectory of the stock market amply reflects these developments. On December 14, the stock had moved up to Rs 288 from Rs 52 on September 13.

RELIANCE PETROLEUM

The buzz over the past three months that the company's largest refinery may go on-stream ahead of schedule has evoked a high interest in the stock, particularly in the F&O segment. Since the re-rating of stock led to a surge in Mukesh Ambani's wealth, speculative activity among retail investors gathered further momentum.

JAIPRAKASH ASSOCIATES

The company has been in the news over the past three months after the Uttar Pradesh government cleared the Taj Expressway project. The company has been in the cement business for a long period. However, it is now active in the infrastructure sector and constructs highways. It has also forayed into the real estate business. The company's plan to move more aggressively in the power sector and its decision to split the face value of shares to Rs 2, has evoked positive response from the market as well. However, the sharp volatility in the S&P CNX Nifty during some sessions has led to heavy volatility in the stock. But surfing on volatility may not be so easy after all. On a particularly bad day, when there are wild swings in the market due to some developments, the loss for intra-day players can be equally fierce. A purchase at the highest level of the day, and subsequent distress-selling during that session at the lowest price due to heavy correction in the market, or some rumours, can cause major erosion in the profits of such an investor. So, investors need to exercise caution and limit their exposure in such a segment until they acquire a better understanding of the overall dynamics.