What is a 'Wasting Asset'

A wasting asset is an item that has a limited life span and irreversibly declines in value over time. Such fixed assets could be vehicles and machinery. However, in the financial markets, the term refers to options contracts.

BREAKING DOWN 'Wasting Asset'

In investing, options are the most common type of wasting asset. An option's value has two components: a time value and an intrinsic value. As the option's expiration date nears, the time value of the option gradually declines to zero. At expiration, an option is worth only its intrinsic value. If it is in-the-money, its value is the difference between the strike price and the underlying asset price. If it is out-of-the money, it expires worthless.

In a similar manner, other derivative contracts, such as futures, have a wasting component. As a futures contract nears expiration, the premium or discount it has to the spot market decreases. However, the value of the futures contract merely approaches the spot value, so in a strict sense it is not a wasting asset. Only the premium or discount wastes away.

Investors should be aware of the time left to expiration for any derivative, but options in particular. Therefore, options strategies tend to be shorter-term in nature

Options traders can turn this problem into a benefit by writing options. Writers, or sellers, of options collect money at the start of their contracts and they get to keep the entire amount, called the premium, if the options expire worthless. In contrast, the buyer of the options loses the entire amount paid, also called the premium, if the options expire worthless.

In an interesting twist, any trader making a directional bet on the underlying asset using 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 of the underlying stock is 50. The trader will make money if the stock moves above 55 plus the premium paid, but it must do so before the option expires. Therefore, if the stock moves up to 54, the trader called the direction of the move correctly but still lost money.

Other Wasting Assets

Outside of the financial markets, any asset that also decreases in value over time is a wasting asset. For example, a truck used for business purposes will decrease in value over time. Accountants attempt to quantify the amount of the decrease by assigning a depreciation schedule, therefore recognizing the decrease in value each year.

A term life insurance policy has a time of expiration and therefore will expire worthless. So does a service contract, for air conditioning repair or other maintenance services, because the holder pays up front and the contract is only valid for a certain period of time.

Finally, 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, depleting the remaining supply. The owner calculates the depletion rate to arrive at an expected life span.

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  1. Does the seller (the writer) of an option determine the details of the option contract?

    The quick answer is yes and no. It all depends on where the option is traded. An option contract is an agreement between ... Read Answer >>
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