What Is a Wasting Asset?
A wasting asset is an item with a finite lifespan that inevitably declines in value over time. Examples include depreciating fixed assets like vehicles and machinery, as well as financial instruments such as options, which experience continuous time decay.
Key Takeaways
- A wasting asset declines in value over time.
- Vehicles and machines are prime examples of wasting fixed assets.
- Naturally exhaustible resources, such as oil wells or coal mines, are also wasting assets.
- In financial markets, options are notable wasting assets due to their diminishing time value as they approach expiration.
Assets That Lose Value
Any asset subject to a decline in value qualifies as a wasting asset. For instance, a business truck will lose value over time. Accountants quantify this loss through a depreciation schedule to systematically recognize the decreasing value.
Other examples include term life insurance policies or maintenance contracts, which eventually expire worthless. Natural resources like coal mines or oil wells have finite lifespans that necessitate a depletion rate calculation, providing an expected lifespan for these resources.
Wasting Assets in Financial Markets
In financial markets, options are quintessential wasting assets. Option value consists of both time value and intrinsic value. Nearing an option’s expiration, the time value erodes to zero. By expiration, an option’s worth is solely based on intrinsic value; if it’s in-the-money (ITM), its value equals the difference between the strike price and the underlying asset’s market price. If it’s out-of-the-money (OTM), it expires worthless.
Other derivatives, such as futures, also carry wasting components. As a futures contract nears expiration, its premium or discount reduces. Unlike OTM options, futures retain some worth at expiration despite the decay, represented by any premium or discount.
Investors closely monitor the expiration of all derivatives, primarily options. Most options strategies target shorter-term gains and typically expire within a year, although long-term equity anticipation securities (LEAPS) extend beyond one year.
An Illustrative Example: Option as a Wasting Asset
Let’s consider an option contract on the SPDR Gold Shares (GLD). Suppose the trust trades at $127, and a trader buys an at-the-money (ATM) call option with a $127 strike price. This option has no intrinsic value but carries a premium of $2.55, translating to $255 for a 100-share contract.
To profit, GLD’s price must exceed $129.55 ($127 + $2.55) by expiration. If the GLD price stays below $127 at expiry, the option expires worthless, resulting in a $255 loss for the buyer. The seller captures the time value or wasting asset portion of the option while the buyer foregoes it.
If GLD is at $128 at expiration, the trader incurs a loss, recovering only $1 while having paid $2.55 premium, totaling a $155 loss for the buyer and $155 profit for the seller. If GLD reaches $132 at expiry, the trader profits by $2.45 or $245 for the contract, while the seller either faces an equivalent loss or opportunity cost.
Depreciation Policies and Financial Strategies
IRS Policy for Asset Depreciation
IRS Publication 946 offers detailed guidelines for taxpayers in claiming depreciation deductions for wasting assets like vehicles.
Leveraging Time Decay in Options Trading
Options traders can capitalize on time decay by writing options. Writers collect premiums—the amount paid by buyers for the option—and keep the entire premium if the option expires worthless. This strategy allows traders to benefit from the natural declining value of wasting assets.
Risks Beyond Time Decay
Beyond time decay, traders can sustain losses if the underlying asset does not quickly move in the desired direction. For instance, a bullish trader buys a call option with a $55 strike price on a $50 stock. The trader profits only if the stock’s price excels $55 minus the premium paid, and before the option expires.
Conclusion
Wasting assets—whether vehicles, non-renewable resources, or financial market options—inevitably lose value over time. Accountants use various methods to account for tangible asset depreciation, while financial markets strategies must precautiously manage the value erosion of options and other derivatives as expiration looms.
Related Terms: depreciation, time decay, intrinsic value, options, futures, derivative.
References
- Cboe. “LEAPS Options”.
