* Britain, France, Arab League say chemical attacks cannot be allowed
* NYSE, Nasdaq at odds over cause of last week's Nasdaq outage
* Indexes down: Dow 0.90 pct, S&P 1.26 pct, Nasdaq 1.79 pct
By Chuck Mikolajczak
NEW YORK, Aug 27 (Reuters) - U.S. stocks dropped on Tuesday on rising geopolitical tensions over the possibility of a military strike against Syrian President Bashar al-Assad's forces for a chemical weapons attack against civilians.
A number of nations and groups, including Britain, France, Canada and the Arab League, joined the United States in urging a firm response to Assad's government and said the world shouldn't stand by as chemical weapons are used.
Western sources who attended a meeting in Istanbul between envoys of an alliance opposed to Assad and the Syrian National Coalition said "action to deter further use of chemical weapons by the Assad regime could come as early as in the next few days."
Defense Secretary Chuck Hagel said U.S. military forces in the region are "ready to go" should President Barack Obama order action against Syria.
Russia's support of Assad in the fighting raises the stakes for financial markets, traders said.
"This is the largest geopolitical risk since the start of the Iraq war," said Michael O'Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.
"I am not saying it will escalate to that point, but this war of words with Russia is the first time the U.S. is pitted against another global (power) in a long time. That creates an uncertainty this market is not accustomed to."
The Dow Jones industrial average fell 135.06 points or 0.9 percent, to 14,811.4, the S&P 500 lost 20.83 points or 1.26 percent, to 1,635.95 and the Nasdaq Composite dropped 65.469 points or 1.79 percent, to 3,592.102.
The White House expects to release a public version of a formal report by the U.S. intelligence community on last week's chemical weapons attack in Syria, spokesman Jay Carney said.
Oil prices rose more than 3 percent on the possibility of a wider conflict that could destabilize the Middle East.
A potential economic headwind for the market is the need to raise the federal government's borrowing authority soon. U.S. Treasury Secretary Jack Lew said it was essential for Congress to raise the borrowing limit by mid-October or the country will face default.
Investor nervousness was reflected in a jump of more than 18 percent in the CBOE volatility index in the last two days.
Gold prices touched a 15-week peak and prices of U.S. Treasuries rose as the geopolitical tension sparked a flight to safer investments.
The benchmark S&P 500 index is down 2.9 percent in August, putting it on track for its worst monthly performance since May 2012.
U.S. regulators have asked Nasdaq OMX Group and NYSE Euronext to come up with a timeline of Thursday's three-hour trading disruption, but the rival exchange operators have been unable to agree on the details, according to several sources familiar with the situation
Shares of J.C.Penney advanced 0.8 percent to $13.46 a day after hedge fund manager William Ackman, the biggest share holder, said he had sold his entire stake after his campaign to overhaul the retailer failed.
Goldman Sachs lost tens of millions of dollars after a computer glitch led to a flood of erroneous options trades last week, a source close to the matter said on Monday. Goldman shares fell 2.2 percent to $154.47.
Shares of Tiffany & Co's dipped 2.4 percent to $79.74 as strong sales in China and higher prices made up for some disappointing business at home in the latest quarter.