OAS for Putable bond should be lower instead?

I’m hoping someone can enlighten me here…

It is mentioned in the Kaplan note that Putable Bond has a larger OAS then an option-free bond since it captures the potatentially favourable impact of the put feature on the investor’s return. I understand that holding a put option is obviously more valuable to the investor. However, it seems counterintuitive to me that with a larger spread meaning the price is cheaper, so it’s cheaper to buy a putable bond than an option free bond? Shouldn’t it get more expensive to reflect the value of the put option? that means investors need to pay more to buy the bond embedded with a put option, and they should take a lower yield reflecting it’s less risky to them? since put option essentialy put a price floor on the bond…

Thank you very much in advance!

Assuming the bonds are priced fairly, the OAS of a putable bond should be the same as the OAS of an otherwise option-free bond.

OAS removes the value of the option.

Thanks but could you elaborate a bit more? that seems a bit contradicting…
you’re saying OAS of a putable bond should be the same as the OAS of an otherwise option-free bond, and for an option-free bond, Z-spread would be the same as OAS. if you’re right then, that means OAS of a putable bond would be the same as Z-spread of an option free bond. that would contradict the materials and examples provided in the Kaplan note…

I don’t know what to tell you about that.

The point of the OAS is to remove the value of any embedded options so that you have a spread that is comparable across all bonds. If you remove the value of the put option, you’re left with an option-free bond, so the OAS is the OAS of the option-free bond.

Yes, yes, and yes.

Assuming, as I wrote initially, the bonds are fairly priced.

I can’t recall what Schweser mentions, but here’s my logic:

  1. The Z-spread and OAS of an option-free bond are the same.
  2. The Z-spread of a putable bond is less than the Z-spread of an option-free bond (because of its lower yield).
  3. The OAS of a putable bond is higher than its Z-spread once the put option is removed.
  4. The OAS of a putable bond may or may not be the same as the OAS of an option-free bond depending on valuation.

The goal is to get a idea of the credit risk that each bond faces. The amount of credit risk is typically represented by looking at the additional yield of a risky bond compared to a credit-risk free bond.

A put option is valuable to an investor, which will increase the price and decrease the yield. Without correction, it will look like this bond has a lower credit risk. However, the put option doesn’t change anything about the credit risk. The OAS is the spread that actually represents the credit risk. By removing the put, the spread will increase, so for a putable bond the OAS will be larger than the apparent z-spread.