It is about a man called Edward "Teddy" Daniels who was a U.S. Marshall , he came to shutter island with his accomplice Chuck on case about a girl missing from the mental hospital. During the search he see's a light house but he is told that it was already searched. He asks to see the hospital personnel files; Cawley refuses, but allows the Marshals to question the staff. They are frustrated to learn that Rachel's psychiatrist, Dr. Sheehan, left on vacation after her disappearance. That night, Teddy has a strange dream in which he sees his wife Dolores Chanal (Michelle Williams), who was killed in a fire two years earlier. She tells Teddy that Rachel is still on the island, as is Andrew Laeddis, the arsonist responsible for her own death.

In the morning, they interview patients from Rachel's group therapy sessions, one of whom distracts Chuck and warns Teddy to run. Later, Teddy reveals to Chuck his ulterior motive for taking the investigation. Andrew Laeddis was sent to Ashecliffe for his crime and then disappeared, motivating Teddy to investigate the institution. He met a former patient, George Noyce, who claimed that Ashecliffe experimented on patients. Teddy is determined to bring the institution down.

Cawley informs Teddy that Rachel has been found and presents her to him. The delusional Rachel (Emily Mortimer) mistakes Teddy for her husband who died in World War II, and then becomes very agitated. Later, Teddy develops increasingly severe migraine headachesaccompanied by hypersensitivity to light. In his sleep he has more strange dreams, followed by waking hallucinations. He is now determined to search for Laeddis in Ward C, which houses the most dangerous patients. There he finds Noyce (Jackie Earle Haley) who is afraid of being taken to the lighthouse, where lobotomies are performed, and tells Teddy that the entire investigation is a game constructed for him.

Teddy rejoins Chuck and they head to the cliffs surrounding the island, intending to reach the lighthouse. Eventually, Chuck suggests that continuing is too dangerous and Teddy goes to the lighthouse alone. He is unable to reach it, and when he returns, Chuck has disappeared. Looking for him at the foot of the cliff, Teddy finds a woman hiding in a cave who confirms his suspicions by revealing that she is the real Rachel Solando (Patricia Clarkson). She says that she was a psychiatrist at Ashecliffe until she found out about the experiments. She was forcibly committed to ensure her silence. She explains that the hospital is using psychotropic medication in an attempt to develop mind control techniques and create "sleeper agent" spies. She says that Teddy has been similarly drugged since he arrived on the island.

Teddy returns to Ashecliffe, where Dr. Cawley tells him that he came to the island without a partner - nobody seems to know Chuck. Teddy eventually makes it to the lighthouse but finds nothing unusual on his way up the stairs, contrary to what he expected. At the top of the lighthouse, he finds Dr. Cawley who reveals that Teddy is not Edward Daniels, but ex-Marshal Andrew Laeddis. Cawley says that he has been a patient at Ashecliffe for two years since he murdered his manic depressive wife in a fit of rage after discovering she had drowned their children. Cawley explains that Rachel Solando never existed, neither as patient nor psychiatrist. "Chuck" then arrives and reveals himself as Dr. Sheehan, Andrew's psychiatrist; the woman who was presented as Solando the patient turns out to be a nurse. Sheehan and Cawley state that Andrew lived the fantasy of still being an active U.S. Marshal, searching for Andrew Laeddis as a means to disassociate himself from what he had done. They show him that the names "Edward Daniels" and "Rachel Solando" are anagrams of "Andrew Laeddis" and "Dolores Chanal", respectively.

Cawley explains that Andrew has gone through repeated cycles of realizing the truth, only to regress into his fantasy again, during which he has injured multiple orderlies and patients, leading the administrative board to demand a lobotomy as a permanent solution to his problem. Sheehan and Cawley explain that they decided to try an experimental therapy, in which they created the role play of "Rachel's" disappearance based on Andrew's fantasy. They say they hoped that by failing to uncover his mind-control conspiracy, Andrew would see reality and return to it permanently. Andrew appears to accept Sheehan's and Cawley's explanations, blaming himself for ignoring Dolores' mental illness until she killed their children. Experiencing yet another migraine, which causes a flashback of the traumatic event of his wife's and children's death, Andrew faints.

The next morning, Andrew once again calls Sheehan "Chuck" and mentions exposing the Island's doings to the outside world. Sheehan silently signals to Cawley, and orderlies approach to take Andrew for the lobotomy. Andrew asks Sheehan whether it is better to "live as a monster, or die as a good man". He then walks off calmly with the orderlies.

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