Binomial Approximations of American Call Option Prices with Stochastic Volatilities

This study describes and tests a simple, efficient method of approximating stochastic volatility call option prices that is lattice based, and can easily accommodate the value of early exercise for American options. The proposed model exploits the fact that stochastic volatility call option prices are approximately linear in the degree of correlation between the asset price and the volatility. By calculating binomial prices for perfect and zero correlations, a simple linear function of the binomial prices can be used to accurately estimate call option prices for any other degree of correlation. A distinct advantage of the model is that it can be easily modified to price American puts.