The story begins with a series of letters between Nathanael, his fiancée Clara, and her brother Lothar. Nathanael describes a childhood fear of a creature called The Sandman who was said to come at night and steal the eyes of children, which intermingled with a the appearance of a man named Coppelius in his father's room some nights to work on what appears to have been alchemy. This man once attacked Nathanael, threatening to take his eyes, and later killed his father before disappearing.
Nathanael has come upon a man, Coppola, at university, whom he believes to actually be that same evil man from his childhood. Upon telling Clara and Lothar of this, they attempt to convince him that it is a childish delusion, and continue to hope he will come to his senses while at home. While he sometimes appears to have forgotten about Coppelius and Coppola, he has periods where it is all he will think or talk about, even coming close to a duel with Lothar after he attacks Clara for calling his story insane.
Nathanael returns to university and meets the daughter of one of his professors, a beautiful but strange girl named Olimpia. He becomes incredibly fascinated and enamored with her, seemingly forgetting Coppelius, Coppola, and even Clara and Lothar. However, one day he hears a commotion and sees that it is the professor and Coppola fighting over the body of Olimpia, arguing about who has made what parts of her; Nathanael realizes that Olimpia has been a doll the entire time. Nathanael returns home once more and seems healed, but when he and Clara go for a walk one day he attempts to throw her on the ground like a doll and Lothar must rush in to save his sister.
The story ends with Nathanael jumping off a parapet to his death, while Coppelius watches and a final domestic scene of Clara, happily living with another husband years later.