UPDATE 1-Options fear gauge soars on credit woes

(Adds VIX closing levels in paragraph 2 and new comments throughout)

By Doris Frankel

CHICAGO, Oct 2 (Reuters) - The Chicago Board Options Exchange Volatility Index .VIX rose sharply on Thursday, suggesting investors are scrambling for protection fueled by worries of widening fallout from the credit crisis.

The VIX, often called Wall Street's fear barometer, rose 13.69 percent to 45.26, near a record close of 46.72 hit on Monday, when U.S. stocks had their worst day since just after the October 1987 market crash.

The VIX pushed past 45 on Thursday as U.S. stocks dropped sharply, weighed down by tight credit markets and disappointing economic data while investors considered whether the U.S. House of Representatives will follow the Senate and pass a massive financial rescue package.

"On Friday, attention will turn to the monthly employment report and the bailout vote, with both events having the potential to break investors nerves before the weekend arrives," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group in Greenwich, Connecticut.

As a result, the cost of buying insurance has increased as investors seek calls in the VIX and put options in the Standard & Poor's 500 index .SPX, he added.

"The VIX is telling us what everybody thinks about the market, and in one word it's uncertainty," said Joe Kinahan, chief derivatives strategist at online brokerage thinkorswim Group in Chicago.

The credit crisis is beginning to hit home across the broad economy. Investors lost confidence in the shares of technology, transport and agriculture-related stocks, Wilkinson added.

"The lack of liquidity in the credit markets is creating havoc everywhere in the marketplace. We need this rescue plan to create stability in the financial markets," said Herb Kurlan, chief executive of Vtrader Pro, a proprietary online trading firm in San Francisco.

The VIX is a measure of expected stock market volatility priced into near-term S&P 500 index option prices. It typically runs inversely to the S&P benchmark, rising when the market suffers steep losses.

SIGNS OF MAJOR MARKET BOTTOM?

Extreme values in the VIX often coincide with signs of a market bottom. Market declines have been followed by short-lived rallies in the past two months.

"This time around the waves of panic get larger and the spikes in the VIX get higher and higher, which tells me that few investors are willing to predict that we are near a bottom, given the grim economic data coming from all quarters," Wilkinson said.

There have been five days in the last two weeks with VIX readings above 40 and the index may see continued high readings, said Chris McKhann, analyst at Web information site optionmonster.com in Chicago.

The high readings indicate that people believe a bottom has not yet been seen, Kinahan said. (Editing by Leslie Adler)