The Z-spread after removing the value of any embedded options, so that callable, putable and mortgage bonds can be compared with plain bullet bonds on equal terms.
A callable-bond yields more than an identical bullet because the investor is short an option to the issuer. Its nominal spread therefore overstates the credit compensation. OAS runs an interest-rate model over many simulated paths, values the option, and reports the spread that remains.
For mortgages the same machinery handles prepayment-risk. OAS is the standard comparison metric across the whole credit and securitised universe, and index-level OAS is what people mean when they quote "spreads" for investment-grade or high-yield.
Example: a callable bond shows a Z-spread of 210 basis points. The model values the call option at 45 basis points of running yield, so the OAS is 165, close to a comparable bullet at 160. The apparent 50 basis point pickup was almost entirely payment for the option.
Original diagrams for the ideas on this page. Illustrative, not real market data.
The bid-ask spread. Buy orders sit below, sell orders above, and the gap between the best bid (50.01) and best ask (50.04) is the spread you pay to cross. Bar length shows the size resting at each price.Buying a call: payoff at expiry. A 105-strike call bought for 3 loses that whole 3 if the price finishes at or below 105, breaks even at 108, then gains a dollar for every dollar higher. The loss is capped at the premium; the upside is not capped.
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