What is Option Cost?
Option Cost represents the value of the borrower's embedded option to prepay the loan early. LoanBook reports it as the larger of Z-Spread minus OAS and zero. A high option cost means the borrower has significant prepayment optionality (high coupon relative to market rates, long remaining term, no prepayment penalties), making the loan more likely to prepay when rates fall. Low option cost means prepayment is less rate-sensitive (short remaining term, call protection, or coupon near market rates). Rate-insensitive assets, such as leases and floaters that reset within 12 months, carry an option cost near zero.
Formula
Option Cost = max(Z-Spread - OAS, 0) Z-Spread and OAS come from the same Hull-White run Positive value = borrower has prepayment optionality
How LoanBook Uses Option Cost
LoanBook derives option cost from one Hull-White Monte Carlo run: OAS is solved across the simulated paths with rate-dependent prepayment, and the Z-Spread is solved on the same run at the path-mean prepayment speed. The difference, floored at zero, is the option cost.
Frequently Asked Questions
Can option cost be negative?
In theory, no; but in practice, small negative values can appear due to Monte Carlo sampling noise. A negative option cost would imply the prepayment option has negative value to the borrower, which does not make economic sense. LoanBook treats small negative values as effectively zero.
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