What does option adjusted mean? Is it WITH or WITHOUT option risk?

CFA Level II Fixed Income
#1

I know z spread has credit + liquidity + option risk. But what does it mean to say OAS only has credit + liquidity risk? When it says option adjusted - does that mean it doesn’t take option risk into account, or it does take option risk into account?

#2

WITHOUT option. Think Option Removed Spread = Option Adjusted Spread

#3

That makes sense - but then why are we using the OAS when working with option bonds if the OAS is the option removed spread? Sorry for the basic question

#4

So that bonds with options are comparable to straight bonds?

#5

OAS is a spread that includes credit risk and liquidity. By using an OAS, you have removed the option value.

For example, Z Spread = OAS + Option Cost for Callable Bond. The OAS = Z-Spread minus Option Cost

For a Putable Bond, Z Spread = OAS - Option Cost. The OAS = Z-Spread + Option Cost.

Just think of it as removing the option value from the bond.