Option-adjusted spread (OAS)
Asset-Backed Securities glossary · Collateral & Cash Flow Modeling
Definition
A spread that accounts for cash flow variability due to embedded options (typically prepayment options); computed via simulation.
Option-adjusted spread (OAS) in plain English
An OAS is a fair-reward spread that first strips out the messiness caused by "embedded options" — special escape hatches baked into a bond. The big one in mortgages is that borrowers can prepay (refinance) whenever they want, which shortens the bond unpredictably and hurts the investor. Because you can't know exactly when people will prepay, analysts run thousands of simulated interest-rate futures, price in that prepayment behavior, and back out the spread that's left over — the true compensation for credit and liquidity risk once the option noise is removed. It's like judging a used car's price only after subtracting the fact that the seller can yank it back early — you want the number that reflects the car itself, not the surprise clause.
Also called: OAS
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