Exhibit 10.40

                             STOCK OPTION AGREEMENT

                  STOCK OPTION AGREEMENT dated as of December 30, 2004,  between
DATA  SYSTEMS & SOFTWARE  INC.,  a Delaware  corporation  (the  "Company"),  and
Sheldon Krause (the "Optionee").

                              Preliminary Statement

                  Pursuant  to the  Company's  1994  Stock  Incentive  Plan (the
"Plan"),  on December 30, 2004, the Board of Directors (the "Board")  granted to
the Optionee an option to purchase 10,000 shares of the Company's  Common Stock,
par value $.01 per share ("Common Stock"), subject to the Plan and the terms and
conditions set forth herein.

                  Accordingly, the parties hereto agree as follows:

                  1.  Grant of  Option.  Subject  to the Plan and the  terms and
conditions of this  Agreement,  the Company hereby grants to Optionee the option
(the  "Option") to purchase from the Company up to 10,000 shares of Common Stock
(the "Shares") at a price per share of $0.91. The number of shares to which this
Option  pertains  and the price per share at which this Option may be  exercised
are subject to adjustment in accordance with the provisions of the Plan.

                  2. Plan Governs Terms of Option.  The Option is subject in all
respects to the terms and conditions of the Plan.

                  3. Type of Option. The Option is not intended to qualify as an
"incentive  stock  option"  within the meaning of Section  422A of the  Internal
Revenue Code of 1986, as amended.

                  4.  Time  of  Exercise  of  Option.  (a)  This  Option  may be
exercised as to not more than 3,332 Shares at any time after  December 31, 2005,
as to not more than 6,665  Shares at any time after  December 31, 2006 and as to
all of the Shares at any time after June 30,  2007  unless  this Option has been
terminated in accordance with the provisions of Paragraph 5.

                  (b) Change in  Control.  Anything  in this  Paragraph 4 and in
Paragraph 5 to the contrary notwithstanding,  this Option may be exercised as to
all the  Shares  (less the number of Shares as to which it has  previously  been
exercised,  surrendered  or  forfeited)  during  the  period  commencing  on the
occurrence  of a (i) Change in Control of the  Company  (as defined in Exhibit A
hereto),  and  ending  on  December  31,  2009,  or  (ii)  upon  an  involuntary
termination as an officer of the Company.

                  5.  Termination  of  Option.  This  Option  shall  immediately
terminate  after  December  31,  2009,  or upon the earlier  termination  of the
Optionee's  service as an officer of the Company  (including,  for this purpose,
any subsidiary of the Company),  except that if the date of such  termination is
after  December  31, 2005,  the  Optionee's  right to exercise  the  unexercised
portion of this  Option  shall  continue  to be  exercisable  but only as to the
number of Shares as to which it would  otherwise  have been  exercisable  for 12
months after the date of such  termination  (but in no event later than December
31,  2009).  The  Optionee's  right to exercise any portion of this Option after
termination  of the Optionee's  employment  with the Company shall be subject to
the  satisfaction  of the  conditions  precedent  that the Optionee not take any
action adversely affecting the Company.

<PAGE>

                  6. Manner of  Exercise.  This Option may be  exercised  by the
delivery to the Company of a written  notice  signed by the Optionee in the form
of Exhibit B hereto, together with either (i) full payment of the purchase price
therefore in cash or by certified  check  payable to the order of the Company or
(ii) irrevocable  instructions to a broker designated or approved by the Company
to sell  shares of Common  Stock  issuable  upon  exercise  of this  Option  and
promptly  deliver to the Company a portion of the proceeds  thereof equal to the
exercise price and any applicable  withholding  taxes.  As provided in the Plan,
the Board may require  Optionee to remit to the Company an amount  sufficient to
satisfy  any  federal,  state or local  withholding  tax  requirements  prior to
delivering to Optionee any shares  purchased upon exercise of this Option.  This
Option may not be exercised with respect to a fractional share.

                  7. Restriction on Transfer. This Option may not be assigned or
transferred except by will or the law of descent and distribution and during the
Optionee's lifetime may be exercised only by Optionee.

                  8.  Notice.   Any  notice  or  communication  to  the  Company
hereunder  shall be in writing  and shall be deemed to have been duly given when
delivered in person,  or by United States mail, to the following  address (or to
such other address as the Company shall from time to time specify):

                            Data Systems & Software Inc.
                            200 Route 17
                            Mahwah, New Jersey  07340
                            Attention:  Secretary

                  IN WITNESS  WHEREOF,  the parties  hereto have  executed  this
Agreement as of the date and year first above written.

                                        DATA SYSTEMS & SOFTWARE INC.

                                        By   /S/ Greorge Morgenstern
                                             -----------------------------------
                                             Name: George Morgenstern
                                             Title: President & CEO

/S/ Sheldon Krause
---------------------------
Sheldon Krause


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<PAGE>

                       EXHIBIT A TO STOCK OPTION AGREEMENT

         A "Change in Control of the Company"  shall be deemed to have  occurred
if (i) there shall be consummated (A) any consolidation or merger of the Company
in which the Company is not the continuing or surviving  corporation or pursuant
to which  shares of the  Company's  Common  Stock would be converted in whole or
part into cash, securities or other property, other than a merger of the Company
in which the holders of the  Company's  Common  Stock  immediately  prior to the
merger have  substantially the same  proportionate  ownership of common stock of
the surviving corporation  immediately after the merger, or (B) any sale, lease,
exchange or transfer (in one transaction or a series of related transactions) of
all or substantially all the assets of the Company,  or (ii) the stockholders of
the  Company  shall  approve  any  plan  or  proposal  for  the  liquidation  or
dissolution  of the  Company,  or (iii)  any  "person"  (as such term is used in
Sections 13(d) and 14(d)(2) of the  Securities  Exchange Act of 1934, as amended
(the  "Exchange  Act"),  other than the Company or a  subsidiary  thereof or any
employee  benefit plan sponsored by the Company or a subsidiary  thereof,  shall
become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange
Act) of  securities  of the  Company  representing  20% or more of the  combined
voting power of the Company's then outstanding  securities ordinarily (and apart
from rights accruing in special  circumstances)  having the right to vote in the
election of directors,  as a result of a tender or exchange  offer,  open market
purchases,  privately  negotiated  purchases or  otherwise,  or (iv) at any time
during a period of two  consecutive  years,  individuals who at the beginning of
such period  constituted  the Board of Directors of the Company  shall cease for
any reason to constitute at least a majority thereof, unless the election or the
nomination  for  election by the  Company's  stockholders  of each new  director
during such two-year period was approved by a vote of at least two-thirds of the
directors  then  still in office who were  directors  at the  beginning  of such
two-year  period or (v) any other event shall occur that would be required to be
reported in response to Item 6(e) of Schedule 14A or Regulation 14A  promulgated
under the Exchange Act.

<PAGE>

                       EXHIBIT B TO STOCK OPTION AGREEMENT

                              OPTION EXERCISE FORM

DATA SYSTEMS & SOFTWARE INC.
200 ROUTE 17
MAHWAH, NJ  07430

Gentlemen:

                  I hereby  exercise the  following  portion of the stock option
that has heretofore been granted to me as follows:

                  Date of grant__________________

                  Exercise price per share $ 0.91
                                           ------------------

                  Number of shares underlying option grant__________________

                  Number of shares underlying option held__________________

                  Number of shares for which option being exercised hereby______

                  In connection with this exercise [check one]:

                  _____ I enclose my check in the amount of $______________

                  _____ I am  delivering  to a broker  designated or approved by
the Company irrevocable instructions to (i) sell shares of Common Stock acquired
upon exercise and (ii) promptly deliver to the Company a portion of the proceeds
thereof equal to the exercise price and any applicable withholding taxes.

                  I  hereby  agree  to  execute  whatever  other  documents  are
necessary in order to comply with the Plan and any applicable legal requirements
in connection with the issuance of the stock to me pursuant to the Plan.

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Optionee (Signature)                              Social Security Number

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Please print name

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Date                                              Address