CdS–ZnO nanocomposite thin films were prepared using the sol–gel technique. Highly confined nanoparticles of CdS (radius 1.8–4.7 nm) were obtained with ZnO as the matrix. The molar ratio of CdS and ZnO was varied within the range 20:80 to 60:40. The influence of the annealing temperature (373–573 K) on the particle size was studied from the blue shift (0.1–0.7 eV) of the absorption edge and transmission electron microscopy. The microstructural characterization by high resolution transmission electron microscopy indicated well-resolved crystalline nanoparticles. Photoluminescence studies indicated three surface related peaks at 2.33, 2.19 and 1.89 eV for all the CdS–ZnO nanocomposites. The optical band gap (Eg) determined without preassuming the nature of the optical transition varied in the range 2.52–3.16 eV with variation of the annealing temperature, showing excellent carrier confinement of the CdS nanoparticles within the wide band gap ZnO matrix. This study indicated ZnO to be a good capping material for CdS nanoparticles.