This is certainly not a fancy activity, but there was almost no prep involved and my kids liked it which makes it a winner for me. I picked up some upper and lower case alphabet letters from Target's dollar spot.
I threw the letters in a paper bag and gave my kids each a cookie sheet. They took turns choosing a letter from the bag and if they could say the name of the letter, they could put it on their cookie sheet. We also talked about the sound the letter makes.
I didn't know if they would go for this activity, but I think calling it a "game" helped. There were certain letters each one of them wanted to collect and when they were finished we spent some time making words.
We also plan to try these letter magnet activities:
Growing Book by Book's Runaway Letter Game
Fun-A-Day's Magnetic Letter Sorts
Kids Activities Blog's Bleached Alphabet Puzzle