Why This Matters
Derivatives are financial instruments whose value is derived from an underlying asset — stocks, bonds, currencies, or commodities. While Angola does not yet have an active derivatives market on BODIVA, understanding these instruments is essential for two reasons: they are used extensively in international markets that affect Angola (oil futures, sovereign CDS), and BODIVA is likely to introduce derivative products as the market matures. Being prepared gives you a competitive advantage.
What Are Derivatives?
A derivative is a contract between two parties whose value depends on the price of something else (the underlying asset). The four main types are:
1. Forwards (Contratos a Termo)
An agreement to buy or sell an asset at a specified price on a future date. Already covered in the FX context — the most common derivative currently used in Angola.
Angola context: BNA and commercial banks offer USD/AOA forwards. Government bond forwards are not yet standardized but may develop.
2. Futures (Contratos de Futuros)
Standardized forward contracts traded on exchanges. Unlike forwards (bilateral, over-the-counter), futures have standard contract sizes, expiration dates, and are marked-to-market daily.
Angola relevance: Brent crude oil futures (traded on ICE in London) directly determine Angola’s primary export revenue. At $75/barrel, Angola’s 1.1 million barrels/day generates approximately $82 million daily. A $10 oil price move changes annual government revenue by approximately $4 billion.
Understanding oil futures helps you anticipate macro impacts: If the oil futures curve is in “backwardation” (near-month prices higher than far-month), it signals tight current supply — positive for Angola. “Contango” (far-month higher) may signal expected oversupply.
3. Options (Opções)
The right, but not the obligation, to buy (call option) or sell (put option) an asset at a specified price (strike price) before or on a specified date (expiration).
Call option: The right to buy. You pay a premium for the option. If the asset price rises above the strike, you exercise for a profit. If not, you lose only the premium.
Put option: The right to sell. Useful as portfolio insurance — if you own BAI shares and buy a put option at Kz 1,100, you are protected against any fall below Kz 1,100.
Angola context: No formal options market exists on BODIVA yet. However, the concept applies: when BODIVA introduces stock or bond options, early adopters who understand the mechanics will have a significant advantage.
4. Swaps (Permutas)
Agreements to exchange cash flows. The most common is an interest rate swap — exchanging fixed-rate payments for floating-rate payments.
Angola relevance: A bank holding fixed-rate government bonds might swap the fixed coupons for floating-rate payments tied to the BNA reference rate, managing its interest rate exposure.
Derivative Use Cases for Angola
Hedging Oil Revenue
The Angolan government and Sonangol could use oil futures and options to hedge against price declines:
- Buy put options on Brent crude at $60/barrel. If oil falls below $60, the options pay the difference, protecting fiscal revenue.
- Cost: The option premium (perhaps $3-5/barrel), paid from the price received on un-hedged production.
Several petro-states (Mexico, most famously) use this strategy. It provides a fiscal floor while retaining upside if prices rise.
Portfolio Insurance
Institutional investors holding BODIVA equities could use put options (when available) to protect against drawdowns:
- Portfolio value: Kz 5 billion in equities
- Buy put options 20% below current levels
- If the market falls 30%, the portfolio loses 20% on stocks but the puts recover most of the additional 10% decline
- Maximum loss capped at approximately 20% + option premium
Interest Rate Management
Banks and bond investors could use interest rate swaps to manage duration:
- Hold long-duration bonds for yield
- Swap a portion of fixed payments for floating
- Result: earn the spread between fixed and floating while reducing duration risk
Understanding Options Pricing
Even without a formal options market, understanding option pricing is valuable. Three factors drive option value:
Intrinsic value: How much the option is worth if exercised right now. A call with strike Kz 1,200 when BAI trades at Kz 100,500 has intrinsic value of Kz 50.
Time value: Options that expire further in the future are worth more — more time for the underlying to move favorably.
Volatility: Higher volatility = higher option prices. More uncertainty means greater chance of large favorable moves. Angola’s market, with its currency, oil, and political risks, would likely have high option premiums — reflecting the genuine uncertainty in the market.
Worked Example: Conceptual Oil Hedge for Angola
Scenario: Angola produces 1.1 million barrels/day, approximately 400 million barrels/year. Current oil price: $75.
Hedge strategy: Buy put options on 200 million barrels (50% of production) at strike $65 for 12 months. Premium: $3/barrel = $600 million total cost.
If oil stays at $75: Options expire worthless. Cost: $600 million. Revenue: $30 billion. Net revenue after hedge cost: $29.4 billion.
If oil falls to $50: Options pay ($65-$50) × 200M = $3 billion. Revenue from unhedged production: 200M × $50 = $10B. Revenue from hedged production: 200M × $50 + $3B = $13B. Total: $23B. Without hedge: $20B. Hedge saved $3B minus $600M cost = $2.4 billion net benefit.
If oil rises to $95: Options expire worthless (as intended). Revenue: $38 billion minus $600M cost = $37.4B. You keep the upside.
The asymmetric payoff of options — limited downside cost, unlimited upside retention — makes them ideal hedging tools for commodity-dependent economies.
Key Takeaways
- Derivatives are contracts whose value derives from underlying assets — stocks, bonds, currencies, commodities
- Four main types: forwards, futures, options, swaps — each with distinct characteristics
- Oil futures directly affect Angola’s economy — understanding them is essential for macro analysis
- Options provide asymmetric risk profiles — useful for hedging and portfolio insurance
- BODIVA does not yet have a derivatives market, but development is likely as the market matures
- Understanding derivatives now positions you ahead of the market when these instruments become available
Common Mistakes
Treating derivatives as gambling — Properly used, derivatives reduce risk. They only become speculative when used without an underlying position to hedge.
Ignoring counterparty risk — Over-the-counter derivatives (forwards, swaps) depend on the other party fulfilling their obligation. Use reputable counterparties and exchange-cleared instruments when available.
Confusing hedging with speculation — Buying options on assets you do not own is speculation. Buying options on assets you hold is hedging. The distinction matters for risk management.
What’s Next
Armed with an understanding of all major financial instruments, the next lesson covers how institutional investors operate in Angola — pension funds, insurance companies, sovereign wealth funds, and their investment mandates.
Next Lesson: Institutional Investing — How the Big Players Operate
Track oil futures impact through the Economy Dashboard. Learn about CMC regulations governing new financial instruments.