I'm with Peter - that's an odd situation. The flashing "digital" indicator suggests that there's no signal coming to the input, which would make me want to check cables and verify that the correct optical port is assigned to the input.

I checked the Sony's manual and agree that there should be no problem with using the optical out in conjunction with the HDMI-to-DVI, as long as the Digital Output setting was still set to "On". I'm a little surprised they still have their digital output defaults set to disable DTS and force a stereo downmix of Dolby Digital, but it shouldn't matter for what you are encountering (although I will hope that Sony support made sure you get those changed so that Dolby Digital was set to "Dolby Digital" and DTS was set to "On").