STOCK OPTION AGREEMENT

            STOCK OPTION  AGREEMENT  dated as of August 19,  2004,  between DATA
SYSTEMS & SOFTWARE INC., a Delaware  corporation  (the  "Company"),  and Shlomie
Morgenstern (the "Optionee").

                              Preliminary Statement

            Pursuant to the Company's  1994 Stock  Incentive  Plan (the "Plan"),
and in accordance with Section 5(f)(ii) of the Employment Agreement, dated as of
January 1, 2004 and  executed  on August 19,  2004,  between the  Optionee,  the
Company and  Databit  Inc.  (a  wholly-owned  subsidiary  of the  Company)  (the
"Employment Agreement"), the Board of Directors of the Company (the "Committee")
has authorized the granting to Optionee of an option to purchase  305,000 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.  The parties
hereto  desire to enter into this  Agreement  in order to set forth the terms of
such option.

            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 305,000 shares of Common Stock (the
"Option  Shares")  at a price per share of $0.71.  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 as amended to date. A copy of
the Plan is available from the Secretary of the Company.

            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 105,000  shares at any time after  August 18,  2006,  as to not
more than 205,000 shares at any time after February 18, 2007 and as to the total
of 305,000  shares at any time after  February  18,  2008 unless this Option has
been terminated in accordance with the provisions of Paragraph 5.

            (b) Change of Control.  Anything in the Employment  Agreement and in
this Paragraph 4 and in Paragraph 5 hereof to the contrary notwithstanding, this
Option may be exercised  as to all the Option  Shares (less the number of Option
Shares as to which it has previously been  exercised,  surrendered or forfeited)
during the  period  commencing  on the  occurrence  of a Change of  Control  (as
defined in Section 6(c) of the  Employment  Agreement) of the Company or Databit
Inc. ("Databit"), and ending on August 18, 2014.
<PAGE>

            5. Termination of Option.  This Option shall  immediately  terminate
after  August  18,  2014,  or upon the  earlier  termination  of the  Optionee's
employment with Databit or the Company,  except that (x) if such termination was
pursuant to Section 6 of the Employment Agreement,  this Option may be exercised
as to all the Option Shares (less the number of Option Shares as to which it has
previously been exercised, surrendered or forfeited) and the Optionee's right to
exercise such unexercised portion shall continue for 12 months after the date of
such  termination  (but in no event later than August 18, 2014),  or (y) if such
termination  was pursuant to Section 7 of the Employment  Agreement and the date
of such termination is on or after August 18, 2006, this Option may be exercised
as to the  number of  Option  Shares  as to which it would  otherwise  have been
exercisable and the Optionee's right to exercise such vested unexercised portion
of  this  Option  shall  continue  for  three  months  after  the  date  of such
termination  (but in no event later than August 18, 2014).  The Optionee's right
to exercise any portion of this Option after any  termination  of the Optionee's
employment  with  Databit or the  Company  shall be  subject  to the  Optionee's
compliance  with (i)  Section 9 of the  Employment  Agreement  (Non-Competition;
Non-Disclosure  of Information) and (ii) Section 10 of the Employment  Agreement
(Mutual Non-Disparagement)..

            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
A hereto,  together with either (i) full payment of the purchase  price therefor
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
Committee 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
<PAGE>

            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/ Yacov Kaufman
                                     -------------------------------------------
                                                  Yacov Kaufman, CFO

                                   OPTIONEE:

                                     /s/ Shlomie Morgenstern
                                     -------------------------------------------
                                                 Shlomie Morgenstern
<PAGE>

                       EXHIBIT A 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                    August 19, 2004
                         -------------------------------------------------------
            Exercise price per share              $0.71
                                    --------------------------------------------
            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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Date                                        Address