So I finally got an HDTV, and games look awesome...
That's not a question.
Why do DVDs look shite?
Because they're still playing at 480p. Your TV probably tells you this when it switches mode. The DVD itself is recorded at a higher resolution than that, though.
Okay, so how do I fix it?
You need the 360 to "upscale" to 1080i. The 360 (if it's new enough to have an HDMI port on the back) contains the hardware to do this, but it won't do it via the component cables you're probably using.
But games are already at 1080i; why not DVDs?
Because Microsoft hate you, and want you to buy a custom Microsoft cable for USD50.
Do I have to buy Microsoft's USD50 cable?
No. All you really need is a standard HDMI cable (which shouldn't set you back more than USD5).
HDMI's selling point is that it does audio and video through a single cable, so that's all I need, right?
No. Not unless you want your audio through the TV's crappy speakers.
But my TV has a TOSlink (optical audio) out; can't I use that?
Not necessarily. Not on a Sony Bravia, for example. Audio that came in via HDMI won't come out via TOSlink, just via the TV's crappy speakers.
Because Sony hate you too, because they know you're a dirty thief who probably half-inched the telly off them in the first place.
Don't forget that Sony are not only the leading consumer electronics company when it comes to proprietary connectors and formats, they're a recording company as well. Twice the evil!
So what do I do?
You need to use an HDMI cable from the 360's HDMI port to the TV for the video, and also run a TOSlink connection from the usual component cable in the back of your Xbox 360 to your surround sound system, like you were already doing.
That is: you need both the old cable and the new cable plugged into your 360 at the same time. You'll use the audio from the old setup and the video from the new setup.
Can I connect an HDMI cable and the component cable at the same time?
Electrically, yes. But Microsoft hate you, remember, so they put the HDMI port so close to the port for the component cable's proprietary connector that when the component cable's plugged in,it overlaps the HDMI port.
So what do I do?
1. You give Microsoft an extra USD50 for their stupid cable. This is probably the best solution.
2. Alternatively, if you like voiding warranties and begrudge those bastards in Washington USD50 that would be better spent on booze and lottery tickets, you take a screwdriver to your component cable, lever the big gray plastic case off, and plug the cable back in to the 360. Removing the plastic means you now have room to slip the HDMI cable in while the component cable is connected. You can find pictures on the web, but note that the plastic case has changed slightly so it's not quite as easy any more, but it's still pretty easy. The hardest part is that you'll have been holding on so tight you probably flipped the SD/HD switch on the side, and you'll want to flip that back.