What Is a Wasted 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.
Assets That Lose Value
An asset is wasted if its value steadily declines over time. For instance, the value of a vehicle utilized for commercial purposes would eventually fall. Accountants use a depreciation plan to identify the declining value annually and quantify the decline.
There are a few exceptions to the general rule that most equipment and cars waste resources. For example, a rare automobile could increase in value over time. If the automobile is well maintained, its value will rise again after a prolonged decrease. However, cars are generally a good use of money since their value steadily drops until they are only suitable for components or scrap metal.
Because a term life insurance policy has an expiration date, it will become useless at that point. Likewise, a service contract that is only good for a certain amount of time and requires upfront payment from the holder applies to repairs or other maintenance services. The value of the contract has been expended and is lost when it expires.
A coal mine or oil well is an example of a natural resource supply that has a finite lifetime and will lose value as the resource is removed and the pool becomes smaller. The owner determines the estimated life lifetime by calculating the depletion rate.
Wasting Money in the Financial Sector
Options are the most prevalent sort of wasted asset in the financial markets. Time and intrinsic value are the two parts that make up an option’s value. Time decay causes the time value of an option to decrease toward zero as the expiry date approaches progressively. An option’s inherent value is all that matters when it expires. Its value is the difference between the strike price and the underlying asset’s price if it is in money (ITM). It isn’t beneficial if it is out of the money (OTM).
Other derivative transactions, such as futures, also have a waste component. A futures contract’s premium or discount to the spot market declines as it approaches expiry. Still, strictly speaking, the futures contract is not a wasteful asset since its value only comes from the spot value. Unlike an OTM option, the futures contract retains value after expiration, meaning that only the premium or discount is lost.
Any derivative’s remaining expiration time should be known to investors, but this is particularly true for options. Most option strategies have a one-year expiration date, making them generally shorter-term. However, longer-term options exist in long-term equity anticipation securities (LEAPS) with an expiration date of one year or more.
To profit from temporal value decay, options traders may also write options. Options writers, also known as sellers, receive payment when they create the contract and retain the whole sum, known as the premium if the option expires worthless. On the other hand, if the option expires worthless, the buyer of the option forfeits the bonus.
If the underlying asset does not move swiftly in the intended direction, any trader placing a directional bet on it via the purchase of options may still lose money. For example, when the underlying stock trades at $50, a bullish trader purchases a call option with a $55 strike price. If the stock rises over $55, less the premium paid, the trader will profit, but only if it does so before the option expires.
Even if the trader correctly predicted the direction of the increase, they would still lose money if the price rose above $54. Even if the stock price increases over the strike ($55) to $56, the trader loses money if the option costs $2. The opportunity costs them $2; thus, to profit, the stock must move beyond $57 ($55 + $2).
An illustration of an option as a wasteful asset
Assume that a trader purchases an SPDR Gold Shares (GLD) option contract. They are buying an at-the-money (ATM) call option with a $127 strike price since the trust trades at $127.
Since this option is ATM rather than ITM, it has no inherent value. As a result, the premium represents the option’s time value. The option carries a $2.55 price and expires in two months. Given that an option contract is for 100 shares, the opportunity costs $255 ($2.55 x 100 shares).
For the call buyer to profit, GLD’s price must increase over $129.55 ($127 + $2.55). The breakeven point is at this moment. The trader will lose $255 if the price of GLD expires worthless and is less than $127. The buyer has lost the option’s time value or wasted asset while the writer has retained it.
The buyer will still lose money if GLD trades at $128 over the strike price when the option expires. The option writer’s profit is $155, but they only get $1 since the option costs $2.55. Hence, they are still losing $1.55.
The buyer will profit enough from the option to pay for the time value if GLD is worth more than $129.55 at expiration, say $132. The buyer’s profit is $2.45 ($132 minus $129.55), or $245 for the contract. If the writer wrote a covered call, they would have an opportunity cost of $245, but if they wrote a naked call option, they would lose $245.
Conclusion
- An asset that loses value over time is considered to be a waste.
- Machines and vehicles are two instances of fixed assets that waste resources.
- Additional instances of squandering resources include depletable resources like coal mines or oil wells.
- Options are a wasted asset in the financial markets, as their time value decreases steadily until they expire at zero.