Option-adjusted spread
The Z-spread with the embedded option's value stripped out, using a model. Comparable across option features, and an opinion rather than arithmetic.
Where you will meet it
Option-adjusted spread appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Contrast the Z-spread with the option-adjusted spread
“The option-adjusted spread takes the Z-spread and removes the value of any embedded option, using an interest rate model.”
- Explain how to apply the arbitrage-free approach when valuing a bond that contains embedded options
“For risky issuers, add a constant spread, the OAS, to each node rate.”
- Weigh the strengths and weaknesses of the different spread measures used in credit portfolios, and show why the option-adjusted spread is the measure of choice
“The option-adjusted spread strips out the option with a rate model, making callable and option-free bonds comparable; its weakness is dependence on the volatility assumption.”
- Explain how option-adjusted spreads are computed and what they are used for
“The option-adjusted spread is the constant spread which, added to every rate in a calibrated tree, makes the model value of a bond with options equal to its market price.”
See also
Practise it
Practise option-adjusted spread until it is automatic: questions that explain every wrong option.
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