CME: E-Mini S&P 500 Put Options (
ES1!
)
Important data releases in the coming weeks would shed light on the health of the US economy and could have significant impacts on global financial markets. We will focus on a number of critical datasets, mainly the following, in the upcoming weeks:
• Federal tax revenue (Tax filing deadline: April 18)
• Existing home sales (April 20)
• Personal income and outlay (April 28)
• Fed rate hike, or the lack of it (May 3)
• Gasoline price trend (before peak summer driving season)
Federal Tax Revenue
According to the US Treasury Department, the sources of tax revenue for US federal government in 2021 were:
• Individual taxes: 42.1%
• Social insurance taxes: 23.8%
• Consumption taxes: 16.6%
• Property taxes: 11.4%
• Corporate taxes: 6.0%
The annual tax filing deadline for individual and corporation is April 18th. In practice, income tax, social security and Medicare are withheld from each paycheck for employees. Corporations pay estimated tax on a monthly basis. Property taxes are assessed annually. Sales tax is paid whenever you buy products or services.
Tax filing is a process where taxpayers calculate tax liability and claim tax credit. If you’ve paid too much, ask for a refund. If you didn’t pay enough, send Uncle Sam a check.
We could track government tax revenue and expenditure using the Monthly Treasury Statement (MTS) data published by the Treasury Department. Here are what I found:
• In the first three months of 2023, gross tax revenue is $2.268 trillion, while tax refund amounts to $219.8 billion; The resulting net tax receipts are $2.048 trillion;
• Comparing to Q1 2022, gross tax revenue is down 0.2%, but tax refunds are up big time by 45.8%. Net tax receipts are down 3.5% year-over-year;
• Q1 individual income taxes $1.22 trillion, tax refunds $192.4 billion and net tax receipts $1.03 trillion; Y/Y changes are -1.9%, +59% and -8.5%, respectively;
• Q1 corporate income taxes (in billions) $159.0, refunds $19.0, and net tax receipts $140.0; Y/Y changes are +5.1%, -20.7% and +10.0%, respectively;
Individual taxes are the most important revenue source for the United States. A declining tax receipt would push the federal budget deeper in the red. But with unemployment at record low and wages on the rise, why is income tax revenue going down?
In 2020, the top 1% of income earners earned 22% of all income and paid 42% of all federal income taxes – more than the bottom 90% combined (37%). For the top earners, most of their income taxes come from capital gain, not from wages.
In 2021, Dow Jones Industrial Average gained 18.7% while the S&P 500 and Nasdaq 100 had annual returns of approximately 27%. I examine the MTS data for April 2022, which covered the tax filing period for year 2021. Net income tax receipt was $1.72 trillion, up 68.5% y/y. This shows positive correlation between stock market gains and growth in individual income tax revenue.
In 2022, the Dow declined 8.8%, while S&P and Nasdaq were down 19.4% and 33.0%, respectively. The individual income tax in Q1 2023 was down 1.9%, but tax refund was up 59%. This again shows positive correlation – stock market losses and decline in income tax revenue.
March MTS data strongly indicates that investors are writing off big capital losses from last year. When the tax season is over, I expect to see bigger tax refund and widening net receipt shortfall in the April MTS data vs same period in 2022.
Implications: Urgency for Debt Ceiling Negotiation
In January, in a letter addressed to House Speaker Kevin McCarthy, Treasury Secretary Janet Yellen warned the US has once again reached its debt limit.
The Treasury Department started taking extraordinary measures to keep paying the federal government’s bills, but it would suspend new investments until June 5, 2023. Yellen warned both moves are subject to “considerable uncertainty” if Congress does not pass the bill to increase the debt ceiling.
US financials have deteriorated since. According to USDebtClock.org:
• US National Debt: $31.69 trillion
• US Federal Spending: $6.03 trillion
• US Federal Tax Revenue: $4.61 trillion
• US Federal Budget Deficit: $1.42 trillion
We now expect tax revenue to decline by at least tens of billions of dollars, while spendings on Defense, Medicare, Social Security, and Debt Interest are all going up. As a result, federal budget deficit could be underestimated by well over one hundred billion dollars.
Would the federal government have enough money to keep the light on until early June? I suspect the insolvency time bomb is ticking closer and closer.
Short-term Trading Strategies
Although we had two rate hikes and a banking crisis in the first 100 days of 2023, major stock market indexes are all in the positive territory. The Dow gained 2.2%, S&P 500 rebounded 7.8%, and the Nasdaq pushed up 19.6% YTD.
While investors managed to brush off bad news so far, balance sheet deterioration in government, corporation and household would eventually catch up. I am seeing a 5-10% correction in the S&P 500, if some of the following conditions materialize:
• Federal tax revenue comes in significantly lower than expected. April MTS report would be released around May 12th;
• May 3rd FOMC: If the Fed raises rates and does not signal an end of the tightening cycle, both corporate earnings and household spending would suffer;
• US banks could tighten lending standards in the wake of banking crisis. This would add to higher borrowing cost on top of the rising interest rates;
• Debt ceiling negotiation: if the White House and the Congress could not reach a deal quickly, we may be heading for the technical default of US government debt. Right now, they are not even sitting at the negotiating table.
Options on CME E-Mini S&P 500 may be a way to express a bearish view. The E-mini S&P 500 Index Futures June contract (ESM3) is quoted 4171.75 last Friday. With a notional value of 50 x S&P 500 Index point, each contract is worth $208,587.5. Put option with a 4070 strike, which is about 100 points below market value, is quoted 76.25. To acquire one option requires an upfront premium of
3
,812.50 (=76.25 X
50
).
Put option carries a nonlinear payoff diagram. Your loss is limited to the premium you paid, but potential gain is unlimited.
Hypothetically, if the S&P futures price falls to 3900, put option will be 170 points in the money (=4070-3900). The gain on the account would be
8
,500 for each contract.
If our view proves to be incorrect and the S&P goes up instead, put premium could decline in value, resulting in a loss. The worst-case scenario is that options would expire worthless.
Happy Trading.
(To be continued)
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/
ES1!
) Important data releases in the coming weeks would shed light on the health of the US economy and could have significant impacts on global financial markets. We will focus on a number of critical datasets, mainly the following, in the upcoming weeks:
• Federal tax revenue (Tax filing deadline: April 18)
• Existing home sales (April 20)
• Personal income and outlay (April 28)
• Fed rate hike, or the lack of it (May 3)
• Gasoline price trend (before peak summer driving season)
Federal Tax Revenue
According to the US Treasury Department, the sources of tax revenue for US federal government in 2021 were:
• Individual taxes: 42.1%
• Social insurance taxes: 23.8%
• Consumption taxes: 16.6%
• Property taxes: 11.4%
• Corporate taxes: 6.0%
The annual tax filing deadline for individual and corporation is April 18th. In practice, income tax, social security and Medicare are withheld from each paycheck for employees. Corporations pay estimated tax on a monthly basis. Property taxes are assessed annually. Sales tax is paid whenever you buy products or services.
Tax filing is a process where taxpayers calculate tax liability and claim tax credit. If you’ve paid too much, ask for a refund. If you didn’t pay enough, send Uncle Sam a check.
We could track government tax revenue and expenditure using the Monthly Treasury Statement (MTS) data published by the Treasury Department. Here are what I found:
• In the first three months of 2023, gross tax revenue is $2.268 trillion, while tax refund amounts to $219.8 billion; The resulting net tax receipts are $2.048 trillion;
• Comparing to Q1 2022, gross tax revenue is down 0.2%, but tax refunds are up big time by 45.8%. Net tax receipts are down 3.5% year-over-year;
• Q1 individual income taxes $1.22 trillion, tax refunds $192.4 billion and net tax receipts $1.03 trillion; Y/Y changes are -1.9%, +59% and -8.5%, respectively;
• Q1 corporate income taxes (in billions) $159.0, refunds $19.0, and net tax receipts $140.0; Y/Y changes are +5.1%, -20.7% and +10.0%, respectively;
Individual taxes are the most important revenue source for the United States. A declining tax receipt would push the federal budget deeper in the red. But with unemployment at record low and wages on the rise, why is income tax revenue going down?
In 2020, the top 1% of income earners earned 22% of all income and paid 42% of all federal income taxes – more than the bottom 90% combined (37%). For the top earners, most of their income taxes come from capital gain, not from wages.
In 2021, Dow Jones Industrial Average gained 18.7% while the S&P 500 and Nasdaq 100 had annual returns of approximately 27%. I examine the MTS data for April 2022, which covered the tax filing period for year 2021. Net income tax receipt was $1.72 trillion, up 68.5% y/y. This shows positive correlation between stock market gains and growth in individual income tax revenue.
In 2022, the Dow declined 8.8%, while S&P and Nasdaq were down 19.4% and 33.0%, respectively. The individual income tax in Q1 2023 was down 1.9%, but tax refund was up 59%. This again shows positive correlation – stock market losses and decline in income tax revenue.
March MTS data strongly indicates that investors are writing off big capital losses from last year. When the tax season is over, I expect to see bigger tax refund and widening net receipt shortfall in the April MTS data vs same period in 2022.
Implications: Urgency for Debt Ceiling Negotiation
In January, in a letter addressed to House Speaker Kevin McCarthy, Treasury Secretary Janet Yellen warned the US has once again reached its debt limit.
The Treasury Department started taking extraordinary measures to keep paying the federal government’s bills, but it would suspend new investments until June 5, 2023. Yellen warned both moves are subject to “considerable uncertainty” if Congress does not pass the bill to increase the debt ceiling.
US financials have deteriorated since. According to USDebtClock.org:
• US National Debt: $31.69 trillion
• US Federal Spending: $6.03 trillion
• US Federal Tax Revenue: $4.61 trillion
• US Federal Budget Deficit: $1.42 trillion
We now expect tax revenue to decline by at least tens of billions of dollars, while spendings on Defense, Medicare, Social Security, and Debt Interest are all going up. As a result, federal budget deficit could be underestimated by well over one hundred billion dollars.
Would the federal government have enough money to keep the light on until early June? I suspect the insolvency time bomb is ticking closer and closer.
Short-term Trading Strategies
Although we had two rate hikes and a banking crisis in the first 100 days of 2023, major stock market indexes are all in the positive territory. The Dow gained 2.2%, S&P 500 rebounded 7.8%, and the Nasdaq pushed up 19.6% YTD.
While investors managed to brush off bad news so far, balance sheet deterioration in government, corporation and household would eventually catch up. I am seeing a 5-10% correction in the S&P 500, if some of the following conditions materialize:
• Federal tax revenue comes in significantly lower than expected. April MTS report would be released around May 12th;
• May 3rd FOMC: If the Fed raises rates and does not signal an end of the tightening cycle, both corporate earnings and household spending would suffer;
• US banks could tighten lending standards in the wake of banking crisis. This would add to higher borrowing cost on top of the rising interest rates;
• Debt ceiling negotiation: if the White House and the Congress could not reach a deal quickly, we may be heading for the technical default of US government debt. Right now, they are not even sitting at the negotiating table.
Options on CME E-Mini S&P 500 may be a way to express a bearish view. The E-mini S&P 500 Index Futures June contract (ESM3) is quoted 4171.75 last Friday. With a notional value of 50 x S&P 500 Index point, each contract is worth $208,587.5. Put option with a 4070 strike, which is about 100 points below market value, is quoted 76.25. To acquire one option requires an upfront premium of
3
,812.50 (=76.25 X
50
). Put option carries a nonlinear payoff diagram. Your loss is limited to the premium you paid, but potential gain is unlimited.
Hypothetically, if the S&P futures price falls to 3900, put option will be 170 points in the money (=4070-3900). The gain on the account would be
8
,500 for each contract. If our view proves to be incorrect and the S&P goes up instead, put premium could decline in value, resulting in a loss. The worst-case scenario is that options would expire worthless.
Happy Trading.
(To be continued)
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/
