Option Cost (Z-Spread minus OAS)

Option Cost = Z-Spread − OAS. It measures how much of the quoted spread compensates for the embedded option rather than credit risk. For a callable bond: Z-Spread = OAS + Option Cost. The option cost is always positive (the call limits upside, costing the bondholder), meaning the issuer effectively keeps some yield compensation for the call privilege. For a putable bond: Z-Spread = OAS − Option Cost (option cost is negative — the put benefits you, so you give up yield). Practical use: Comparing option cost across callable bonds reveals which have the most expensive call features embedded in their price. A bond with 150bp Z-Spread and 120bp OAS has a 30bp option cost — the market prices the call at 30bp. A higher option cost means the bond is more likely to be called.