Grabner, one of three finalists for the NHL's rookie of the year award, did not start the season with the Islanders but he ended it as the team's goals leader with 34.
"I'm really happy knowing I'll be staying here on Long Island," the 23-year-old said in a statement.
"We have a lot of young, talented players who came together last year and I am thrilled to have the chance to be a part of getting this team back to the playoffs."
Grabner had a six-game goal streak in February that matched the longest by any player all season. His 52 points was third among rookies.
"Michael showed last season that he is an elite player in this league," Islanders General Manager Garth Snow said.
"In addition to providing speed and skill to our offense, he's worked hard to elevate the defensive side of his game to become an all around player."
Grabner is vying with San Jose Sharks center Logan Couture and Carolina Hurricanes center Jeff Skinner for the rookie of the year award. The winner of the Calder Trophy will be announced on June 22 at the NHL Awards in Las Vegas.
(Writing by Mark Lamport-Stokes; Editing by Peter Rutherford)