Interactive Brokers Chief Strategist Steve Sosnick joins Yahoo Finance Live to discuss how investors can approach pullbacks in the market as the Fed signals upcoming rate hikes.

Video Transcript

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BRIAN SOZZI: January hasn't been too kind to the bulls as traders hit reset on hot areas of the markets with interest rate increases around the bend. So will February be any better? Steve Sosnick is the chief strategist, Interactive Brokers, and is here with us now.

Steve, always nice to see you. As someone who religiously follows all the moves and options-- probably futures, stock markets-- is there any sense that we may see investors step up here in the first part of February and go shopping for stocks that have been sold off aggressively?

STEVE SOSNICK: Good morning, Brian. Yeah, of course. I mean, buy the dip has been a strategy that's worked-- you know, first of all, it's probably been a strategy that's worked, you know, since there have been markets. But, you know, a lot of investors have been trained to realize that buy the dip works.

Now, to be, you know, to be glass half-empty about it, the environment is changing. And I think investors and traders need to recognize that. But the impulse to look for stuff that's beaten down any time you get a move like this, where a lot of stuff is beaten down, there will be bargains to be had. And it's human nature to expect people to be looking for them. The question is, are you doing it reflexively or are you doing it intellectually?

BRIAN SOZZI: Well, the question also, Steve, I would argue is, buy the dip, to your point, has worked very well for investors. But, ahead of what looks to be a series of rate hikes, do you think the Fed ultimately crushes out that mantra, that buy the dip mentality that has worked so well?

STEVE SOSNICK: Yeah, and I think that's exactly it. I think-- think of all the investors who've joined the market, let's say, over the past two years, since March 2020. They've known an environment of perpetual monetary stimulus, of recurring bouts of fiscal stimulus, you know, of various payment moratoria.

That's really unnatural. And now you've got the Fed shifting gears. One of the things I've been trying to do in my work is there's two parts to the phrase. It's buy the dips and sell the rips. We've kind of forgotten the second part of that.

And I think that this is an environment where you're going to get the opportunity to do both, whereas, over the last, you know, call it since March 2020-- I'm just gonna use two years as a shorthand-- over the last two years, selling the rips wasn't really a great strategy unless you were just trying to lock in a gain, because most things continue to move higher. We're really seeing an erosion in that, and you alluded to that in your prior segment with a lot of the real winners that had been working for people just not working anymore.

JULIE HYMAN: So there's something else I want to bring into this, which is kind of what Sozzi mentioned as well, and that's options activity. And I know you guys, you told us on your platform, Interactive Brokers, you've seen a 60% increase in options volume in the 25 most active names.

Now, when we see the kind of activity we've seen in the market, in other words-- what am I trying to ask here? If people are playing all of this through options, does that mean their downside in these recent selloffs has been limited? And does that mean you don't get the typical capitulation or exhaustion or end of a downturn that you would typically get? Is there any kind of that interplay?

STEVE SOSNICK: The difference is if you're speculating with options, it's more death by 1,000 cuts because, you know, assuming you're speculating by buying put and call options, your downside-- you know, an advantage to it is your downside is predetermined. It's whatever the premium you've paid.

So, you know, that actually, in many ways, until you run out of ammunition for doing that, you're going to keep doing it. The pickup in volume that we saw over the last week, I guess, makes sense because the volatility was enormous. Think about the intraday swings that we had, you know.

And, you know, just think about over the last-- since Martin Luther King Day, we've had some staggering moves. And so, you know, in many ways, the best way to play that is indeed via options. And also, I do think you started to see people clamoring for protection, which is what you saw, you know, in the sharp rise in VIX.

The interesting thing to me is-- I haven't redone the work this morning. But, as of last week, as of last Friday, prior to when we started to rally throughout all of last week, people were pricing in upside. The highest-probability outcome on S&P options-- we have a function called Probability Lab that sort of displays this as a histogram-- the peak probability was up 1% to 3% depending on where you were-- depending on which month or expiration you were looking at.

So there is still a lot of residual bullishness out there. That's not necessarily wrong. But, you know, it's going to be a process as people readjust their thinking about markets.

BRIAN SOZZI: My fellow Sos starting the week correctly for us. Steve Sosnick, chief market strategist over at Interactive Brokers. Always good to see you. We'll talk to you soon.