For options that benefit the issuer, such as calls, investors will want yield spreads that are greater than bonds and that do not have options embedded in them. Because there is a risk that the bonds will be called, investors want a higher yield to compensate for that risk, causing the spread to widen over the treasury security when compared to bonds without options. The longer the call period, the less spread widening investors will be needed because of a longer protection period against the call.

Options That Benefit the Holder
For options that benefit the holder, such as puts, investor will require a smaller yield spread than bonds that do not have embedded options in them, such as treasury bonds. There is even the possibility that the coupon rate could be lower than the treasury coupon rate, depending on how favorable the option is to the investors.

Spreads and Liquidity
When issues are less liquid, yield spreads tend to widen because there are fewer bonds to buy or it is harder to find a buyer. When issues are more liquid, such as on-the-run treasuries, yield spreads are tighter or narrower because there are plenty of buyers and sellers.

The larger the issue size, the more liquidity compared to a smaller issues in the market leads to tighter or narrower spreads and vice versa.
After Tax Yield of a Taxable Security

Related Articles
  1. Trading

    Explaining Credit Spread

    A credit spread has two different meanings, one referring to bonds, the other to options.
  2. Investing

    How To Calculate The Bid-Ask Spread

    It's very important for every investor to learn how to calculate the bid-ask spread and factor this figure when making investment decisions.
  3. Investing

    Guide To Embedded Options In Bonds

    Investors should be aware of embedded options that may be available in certain securities as these options may affect the value of the security.
  4. Trading

    Which Vertical Option Spread Should You Use?

    Knowing which option spread strategy to use in different market conditions can significantly improve your odds of success in options trading.
  5. Investing

    What's the Option-Adjusted Spread?

    The option-adjusted spread, or OAS, measures a fixed-income security rate’s spread and the risk-free rate of return that’s adjusted to account for an embedded option.
  6. Investing

    Investing in Bonds: A Look at Returns and Risks

    A look at the risks, returns and ratings of different types of bonds.
  7. Investing

    Understanding the Different Types of Bond Yields

    Any investor, private or institutional, should be aware of the diverse types and calculations of bond yields before an actual investment.
  8. Trading

    Get Familiar with These 6 Option Strategies

    When you’re ready to move beyond the basics of investing, it’s time to learn your options.
Frequently Asked Questions
  1. Is it possible for a country to have a comparative advantage in everything?

    Learn whether one country can have a comparative advantage in everything and what the difference between comparative advantage ...
  2. What's the difference between publicly- and privately-held companies?

    Privately-held companies are owned by the company's founders, management, or private investors. Public companies are owned ...
  3. What Are Short-Term Investment Options?

    If you only have a short period of time in which to invest your money, there are several short-term investment options you ...
  4. What are leading, lagging and coincident indicators?

    Leading indicators move ahead of the economic cycle, coincident indicators move with the economy, and lagging indicators ...
Trading Center