* U.S. manufacturing sector contracts in May -ISM
* Equity option market sentiment has turned from bullish to cautious: Credit Suisse
* Merck shares rally early stage study of tumor drug
* Indexes mixed: Dow up 0.3 pct; S&P down 0.2 pct; Nasdaq off 0.5 pct
By Angela Moon
NEW YORK, June 3 (Reuters) - U.S. stocks were mostly lower by late morning trade on Monday in a volatile session as investors booked profits from a brief gain earlier that followed lukewarm manufacturing data.
The S&P 500 fluctuated between losses and gains during most of the morning, but the blue chips were outperforming the market - of the 30 stocks on the Dow, 25 were trading higher, including Merck & Co and Intel Corp.
"The near-term psychology of the equity market appears to be inconsistent and inconclusive," said Terry Sandven, chief equity strategist at U.S. Bank Wealth Management in Minneapolis, adding that trading is likely to become more volatile.
"Today's (ISM) numbers were basically in line with expectations, and will serve as a reason for the Fed to continue to move towards tapering, (but only) in the latter part of the third quarter or fourth quarter. But a consolidation period is inevitable at these levels."
U.S. manufacturing activity contracted in May for the first time in six months as new orders slipped and there was less demand for exports, an industry report showed on Monday.
Trading has been volatile for the past week, with intraday swings of 1 percent up or down, on concerns that the Fed may reduce its monetary stimulus earlier than expected.
The Dow Jones industrial average was up 39.62 points, or 0.26 percent, at 15,155.19. The Standard & Poor's 500 Index was down 3.54 points, or 0.22 percent, at 1,627.20. The Nasdaq Composite Index was down 16.44 points, or 0.48 percent, at 3,439.47.
A popular options gauge that measures the level of anxiety in the market also showed a jump. The CBOE Volatility index VIX was up more than 2 percent at 16.64.
"Equity option market sentiment has turned from bullish to cautious, with VIX, skew, vol-of-vol (volatility of volatility), and correlations all experiencing notable gains over the past two weeks," said Mandy Xu, equity derivatives strategist at Credit Suisse.
In a week of heavy data, the most important will be the May nonfarm payrolls report, scheduled for Friday. Reuters' survey of analysts shows an expected 170,000 jobs added, slightly higher than the previous 165,000. The Fed's Beige Book survey of regional conditions is on tap for Wednesday.
In company news, Merck shares rose 5 percent to $49 after the company's drug designed to unmask tumor cells and mobilize the immune system into fighting cancer helped shrink tumors in 38 percent of patients with advanced melanoma in an early-stage study.
But F5 Networks Inc fell more than 5 percent to $78.44 after Morgan Stanley downgraded the network gear maker to "equal weight" from "overweight".