You can do both.
If you still have the retail hdd then ftping games to it is not really an option, but if you upgrade it you can ftp all your games and play from the hdd.
If you want to make backups on cd/dvd first find out what media works best in your machine.
Then using a ftp program connect your xbox to your pc, insert your game into the xbox dvd drive and copy all of the game files across to your pc.
Using one of the many XISO programs turn those game files into a xiso and use nero to burn the image.
Hope this helps.