The options market “looks at” US stocks in 2026: the probability of experiencing a 30% sharp drop is 10%, be wary of the “pain index”
The Zhitong Finance App learned that a recent analysis by TS Lombard economist Steven Blitz (Steven Blitz) shows that the options market currently estimates that the probability of the S&P 500 falling 30% or more at some point in 2026 is 8-10%.
By looking at the S&P 500 put options due in December 2026, Blitz found that their pricing was highly consistent with the historical average. Since World War II, the average interval for the S&P 500 index to fall by 30% or more (measured from peak to peak) is 12.7 years. Since 1982, this average interval has been reduced slightly to 11.8 years. Blitz wrote in the research report: “An 8% probability corresponds to the historical average frequency (a sharp drop every 12.5 years), and a 10% probability means one-tenth of a chance.”
Plummeting falls often follow
However, Blitz warned that the frequency of sharp market declines is often characterized by clusters — occurring one after another in a short period of time, followed by a long period of calm. From 1966 to 1982, there were five declines of 20% or more, with an average interval of only 3.7 years. In contrast, from 1982 to 2019, there were only three such declines, with an average interval of nine years.
The key to distinguishing these two periods is the trend of the “pain index” (the sum of the unemployment rate and the year-on-year inflation rate). The pain index rose from 5.5 to 16 during the period of frequent market crashes from 1966 to 1982. In the period of less sharp decline from 1982 to 2019, the index fell back from 16 to 5.5. Currently, the pain index has risen from 5.2 in 2019 to 7.4, which suggests that the economy may be entering a period of more frequent recessions.
The gig economy masks weakness
Blitz pointed out that the gig economy has become a “safety valve” for unemployed workers, which helps explain why unemployment has not translated into a surge in unemployment insurance claims. “For example, the income from driving an Uber is higher than unemployment insurance benefits, there is no time limit for receiving it, and as long as high-end jobs remain stable — this is largely due to stable or rising stock values — this income will continue.”
In November, the number of non-corporate self-employed workers surged from 9.7 million in September to 10.3 million, while the share of workers with multiple jobs at the same time rose from 5.4% to 5.7% of total employment, the highest level since the 2008-09 recession.
The stock market is still overvalued
In the context of this weakening economy, Blitz observed that the stock market is still overvalued by most measures, and its proprietary liquidity index also suggests that the stock market is facing downward pressure. Despite popular opinion predicting stronger economic growth in 2026, accompanied by higher inflation, Bullitz expressed caution: “When a outlook seems so clear, it rarely develops as expected.”
He concluded that although the pricing of the options market seems reasonable based on historical averages, the current pressure on the US domestic and global economy, overvaluation of the stock market, and rising pain indices all together suggest that downside risk insurance (i.e. put options) may still be underpriced.
He said, “This is not a prediction of a sharp decline, but then again, no one can predict that their house will burn down, but people will still buy fire insurance. Insurance always seems cheap when you don't need it. That's the point.”