I am a high frequency secondary market trader - ask me anything

[lendingmachine]

Greetings,

I'm an individual investor who makes extensive use of lendingclub's api for trading notes on the secondary market.  I have made approximately 40,000 trades in the last year and my ROI for 2018 was approximately 26% on a 100k portfolio.  Many of the strategies I use cannot be scaled up though.  I would expect as I invest more capital my returns would level out around 12-16%, although it is hard to say because I have put the majority of my time and energy into optimizing the performance of the capital I have available.     I have likely put in close to 1000 hours of time to develop this trading program.  Everything is written in python.  The buy side runs on gcloud instances in a linux environment and the sell side happens from my home computer.
     While I cannot give away the most specific details of my trading strategy, I hope that I can answer any questions people might have and perhaps find a few people to collaborate with.  I do have a system in place to get lightning fast execution on purchasing notes on the secondary market.  The key is to have a buy price already calculated for every note on the platform.  I have collected the data that lendingclub releases monthly for the last two years so that I have a database of fico score trends for every note.  A large portion of the pricing model I use looks at the pattern of fico scores as well as measuring volatility of the fico score.  Factors such as income and credit history matter two, but once a note has 18-24 months of payments under its belt I have found the highest correlations of performance with fico trend and interest rates.  I run about 20 different strategies and I am trying out new ones all the time. 

Profit comes from four main areas:

     1) Buying grossly underpriced notes.  Notes are frequently listed for sale on the secondary market that are grossly underpriced, but they are snatched up in milliseconds.  Being the first to purchase these is highly profitable, but limited in scope.  I estimate that with perfect execution one could make approximately $40k per year from this

     2) Spread between buy price and sell price on normal notes.  I am constantly listing my inventory for sale at 3-5% over the price I pay of the notes (of course this would be much higher if I bought the loan at a larger discount).  I could theoretically lower this margin to anything over 1% fee lendingclub charges for sales.  However any shortcoming in my model could theoretically be exploited by others with such a low spread.  3-5% gives me plenty for margin of safety and allows me to buy and sell about 100 notes a day. 

     3) Returns from a refined portfolio.  I have gradually accumulated the majority of my holdings in a portfolio of loans that is 17% return or greater and greater than 60 change in fico score.  I sell the notes automatically that drop in fico score and my default rate on this portfolio is very low.  I am in the process of accumulating more notes that are in professions that would be resistant to a recession or downturn in the economy.

     4) Buying and selling delinquent notes.  Everything from grace period to notes about to default.  The market for these notes swings pretty wildly.  These strategies are limited due to the limited amounts of notes available but some of my strategies have yielded over 100% ROI on an principle of several thousand dollars.


I am considering putting more capital into this project but I am hesitant to have all of my eggs in one basket.  I am looking for good ways to hedge against a recession, and the increased unemployment and defaults that would come along with it.  I have considered buying SPY Put options at a 30-40% lower strike price than the spot price.  Other possibilities would be put options for lendingclub itself and for a consumer discretionary sector ETF.  If any financial pros have other suggestionsl I would be very eager to hear them.

I am starting to buy some notes on the primary market to see what kind of return I can get.  This strategy will involve selling both highly performing and underperforming notes on the secondary market for a profit, but only buying notes on the primary market.  The return I generate from this strategy could theoretically be scaled up much higher and perhaps later on I could offer a product to invest money on behalf of others. 


I'm open to any questions.  I'm will try to be as specific as I can in my responses to the extent that it would not generate competition for myself.  I really do love this work I am doing.  When I've played mmorpgs in the past my favorite part has always been the auction house or the in game economy.  I feel like this project has allowed me to channel that same creativity and drive.

Ask me anything

[PeerLoanAdvisor.com]

I am very impressed with your knowledge of the secondary market and congrats on doing so well. I agree that pricing inefficiencies are abundant in this market. Unfortunately, the opportunities are limited. I am focused on the primary market and, as you note, there is virtually no limit to the capital that can be invested this way.

[jdheitmann]

Hi there - great post.  Considering the amount of short term sales you're doing, is your 26% ROI before or after taxes on short-term capital gains?

I also do automated trading, but I hold all notes to maturity and do not sell anything other than at-risk notes.  My focus is on buying high-quality notes that meet my investment objectives.

Thanks!
Jason