What is an option-adjusted spread?

An option-adjusted spread is a measure of the rate of return on a bond that has embedded options as compared to treasury bonds, which are risk-free. The option-adjusted spread is typically added to the fixed returns on similar risk-free securities to determine a bond's yield.

The OAS is typically applied to cushion an investor against the risks associated with an options-embedded bond. Analysts normally rely on the OAS to determine whether the price of a bond is worthwhile after factoring in the risks of prepayments and changing interest rates. Mortgage-backed securities typically apply the OAS to cover the risk of early repayments.