Nabokov, claimed off waivers by the Islanders last year after a season playing for St. Petersburg in the Russian Kontinental Hockey League, has been one of the few bright spots for the struggling Islanders this season.
A two-time All-Star and Calder trophy winner as NHL rookie of the year, Nabokov has posted a 17-18-3 record with a 2.56 goals against average for the Islanders, who sit second last in the Eastern conference.
"Evgeni has proven that he can still play at an elite level in the NHL," said Islanders general manager Garth Snow in a statement.
"He's given us a chance to win every night and we're excited to have him back for another season."
Taken in the ninth round of the 1994 NHL draft by San Jose, Nabokov spent 10 seasons with the Sharks appearing in 80 playoff games.
He has also represented Russia at two Winter Olympics and two world championships, winning gold in 2008.