Daniloff, the Moscow correspondent for U.S. News & World Report magazine, was arrested by the KGB Aug. 30 and charged Monday with espionage. His arrest came one week after physicist Gennadi Zakharov was arrested by the FBI for spying. Zakharov, who lacks diplomatic immunity, was indicted Tuesday on three counts of espionage.
U.S. officials maintain that the Soviets framed Daniloff on espionage charges in order to work out a trade for Zakharov, who the Justice Department insists will have to stand trial.
The diplomatic discussions, which one U.S. official described as "very intense negotiations," continued amid word that Soviet leader Mikhail S. Gorbachev has called for a speedy resolution of the matter.
Gorbachev, in a personal letter to President Reagan, urged that the two countries move quickly to settle the dispute and outlined his thinking for how that might be accomplished, sources said. The sources would not discuss his proposals.
Gorbachev also expressed concern in his letter that the incident might get out of hand and jeopardize U.S.-Soviet relations in other areas, according to the sources.
The Soviet leader's letter was in response to a letter Reagan wrote last week in which he assured Gorbachev that Daniloff was not a spy and urged that the journalist be released promptly.
Like Gorbachev, Reagan also has expressed concern that the incident could disrupt superpower relations. He has ordered his aides to pursue all diplomatic channels for resolving it before it produces a major rift and jeopardizes plans for a summit meeting this fall or winter.
Thus, while the administration is prepared to begin expelling diplomats and Soviet U.N. employees and to take other punitive steps if Daniloff is not released soon, those actions have been kept in reserve and the administration has refrained from public attacks on the Soviets in the hope that a diplomatic solution can be found.
"If you've got negotiations going on like this, you obviously have hope of reaching a resolution," said one official. " . . . We haven't given up. We're still working on it."
The Reagan administration has proposed that if Daniloff is released and allowed to come back to the United States, the Justice Department would recommend that Zakharov be released to the custody of the Soviet ambassador while he stands trial.
A Soviet proposal for a direct trade, however, has been rejected by Reagan.
A U.S. source familiar with the negotiations said one possible solution would involve a different trade if Daniloff is released first. Under this formula, Zakharov would be tried, convicted and jailed for a week or two, and then traded for a Soviet dissident or other prisoner.
The Soviets, however, have not seemed interested in such an approach and have proposed instead that both Zakharov and Daniloff be released in the custody of the ambassadors of their respective countries while both stand trial.
An administration official said that despite the differences aired in public, there were private indications "that things may be moving in the right direction."