What Is a Wasting Asset?
A wasting asset is an item that has a limited life span and irreversibly declines in value over time. Examples include depreciating fixed assets such as vehicles and machinery and securities with time decay, like options, which continually lose time value after purchase.
Key Takeaways
- A wasting asset declines in value over time.
- Vehicles and machines are examples of fixed assets that are wasting assets.
- Examples of wasting assets include exhaustible resources such as oil wells or coal mines.
- In the financial markets, options are a wasting asset because their time value continually diminishes until zero at expiration.
Assets That Lose Value
Any asset that decreases in value is a wasting asset. A truck used for business purposes will decreasein value over time. Accountants attempt to quantify the decrease by assigning a depreciation schedule torecognize the loss.
A term life insurance policy or a maintenance contract has a time of expiration and will expire worthless. A natural resource supply, such as a coal mine or oil well, has a limited lifespan and will decrease in value as the resource is extracted and the remaining supply is depleted. The owner calculates the depletion rate to arrive at anexpected life span.
Wasting Assets in Financial Markets
In the financial markets, options are the most common type of wasting asset. An option's value has two components: time value and intrinsic value. As the option's expiration date nears, the time value gradually declines toward zero. At expiration, an option is worth only its intrinsic value. If it is in the money (ITM), its value is the difference between the strike price and the underlying asset's price. If it is out of the money (OTM), it expires worthless.
Other derivative contracts, such as futures, have a wasting component. As a futures contract nears expiration, the premium or discount decreases. Only the premium or discount wastes away, and the futures contract is worth something at expiration, unlike an OTM option.
Investors watch the expiration for any derivative, especially options. Options strategies tend to be shorter-term, most expiring within one year. There are longer-term options called long-term equity anticipation securities (LEAPS), which expire in one year or longer.
Example of an Option as a Wasting Asset
Assume a trader buys an option contract on the SPDR Gold Shares (GLD). If the trust trades at $127, they buy an at-the-money (ATM) call option with a strike of $127. This option has no intrinsic value since it is ATM and not ITM. The option, which expires in two months, has a premium of $2.55. The option costs $255 for an option contract of 100 shares ($2.55 x 100 shares).
For the call buyer to make money, the price of GLD will need to rise above $129.55 ($127 + $2.55). This is the breakeven point. If the price of GLD is below $127 at expiry, the option will expire worthless, and the trader will lose $255. The writer has captured the time value or wasting asset portion of the option while the buyer has lost it.
If GLD trades above the strike price at $128 at the option's expiry, the buyer will still lose money. They are fetching $1, but the option costs $2.55, so the loss is $1.55 or $155, which is the option writer's profit.
If the price of GLD is above $129.55 at an expiry of $132, then the buyer will cover the cost of the time value. The buyer's profit is $2.45 ($132 - $129.55), or $245 for the contract. The writer loses $245 if they wrote a naked call option or has an opportunity cost of $245 if they wrote a covered call.
What Is the IRS Policy for Depreciation of Assets?
IRS Publication 946 provides guidelines for taxpayers to claim depreciation for wasting assets such as vehicles.
How Do Options Traders Take Advantage of Time Decay?
Options traders can write options to take advantage of time value decay. Sellers of options collect money when they write the contract and keep the entire amount, called the premium if the option expires worthless. In contrast, the buyer of the options loses the premium if the option expires worthless.
In Addition to Time Decay, When Do Options Traders Lose Money?
Any trader making a directional bet on the underlying asset by buying options can still lose money if the underlying does not move in the desired direction quickly. For example, a bullish trader buys a call option with a strike price of $55 when the current price is $50. The trader will make money if the stock moves above $55minusthe premium paid, but it must do so before the option expires.
The Bottom Line
A wasting asset, such as vehicles, non-renewable resources, and financial market options, declines in value over time. Accountants use depreciation formulas to account for the loss of tangible assets, like a work truck. In the financial market, traders can lose money as options move toward expiration and the investment vehicle loses value.
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