An OAS model will be used to compare the relative value of a puttable or callable bond vs. an otherwise option free bond. The Z-spread will be the appropriate for the option free bond. I think people are getting confused because the put and call aspects of option related bonds have opposite effects on their value. A call option will detract from the bond’s value since it gives the issuer the right to call it back at some specified level. Investors will have to be compensated for this reduction through more attractive terms, higher rates. A puttable bonds is of value to the bond holder since it offers the right to put the bond back to the issuer. Investors buying a putable bond will have to pay for this right through lower a lower rate.
The OAS strips out the option feature of the bond so it can be compared on a relative, apples-apples, basis to a similiar, option-free bond. If the OAS > Z spread the bond is tradaing cheap. Spreads are measured in terms of basis pts, keep in mind the price/yield inverse relationship, so greater amount of basis pts over benchmark, higher yied…lower price. OAS < Z bond is trading rich vs similiar option free bond.