The 2003 Champions Tour player of the year tapped in for par and won when defending champion Lee Trevino three-putted from 25 feet for bogey.
Arnold Palmer, who failed to win a skin the past two years, was second with $140,000, Jack Nicklaus made $60,000 and Trevino was shut out.
Watson, 54, was the youngest of the foursome and the longest hitter, hit the green with his approach shot on the third extra hole then two-putted from 35 feet for the win.
Watson has won 39 times on the PGA Tour, including eight majors. He won the Senior British Open and the Tradition last year, two majors on the Champions Tour.
Palmer, playing in his 50th professional season, began the day in third place with $50,000.
Palmer, 74, and Nicklaus were eliminated on the first extra hole after failing to birdie. It was the 16th Skins appearance for Palmer, who won the event in 1990, 1992 and 1993. Nicklaus, the 1991 winner, entered for the 14th time.
Using a cross-handed putting grip for the second day, Palmer holed a 12-foot birdie putt on the 167-yard No. 11 to take three skins and $90,000. That pushed his winnings to $140,000 and gave him his first lead - $70,000 lead over Watson.
Watson threatened to regain the lead on the next hole by sinking a winding 25-foot birdie putt. But Palmer calmly rolled in a 10-foot birdie putt to halve the hole.
It was Palmer's fifth birdie in seven holes.
'I'm going cross-handed tomorrow,' Trevino said.
Watson tied Palmer for the lead by sinking a 10-foot eagle putt on the 530-yard 13th hole. The birdie, set up by a fairway wood shot from 255 yards, earned Watson earned two skins and $70,000.
On the final hole in regulation, Watson missed an 8-foot birdie putt, setting the stage for Palmer. But Palmer couldn't sink his 7-foot birdie putt, sending it into a playoff.
Nicklaus, sixth last week in the season-opening MasterCard Championship after turning 64, began the day in second place with $60,000.
He struggled with his tee shots Saturday and failed to pick up a skin on the back nine.
Trevino, 64, was visibly bothered by a left hip injury he suffered a few weeks ago when he fell in a bunker in Texas.
Last year, Trevino holed a 10-foot birdie putt on the third extra hole to finish with six skins and $240,000, preventing Hale Irwin from claiming his fourth straight title.
This year's quartet has combined to win 258 events on the PGA and Champions tours, including 39 majors and more than $51 million.
The first six holes were worth $20,000, Nos. 7-12 $30,000, the next five $40,000 and No. 18 $100,000.
Saturday's gallery was estimated at 4,000, double Friday's crowd. One of the biggest draws was 14-year-old Michelle Wie, who played in Nicklaus' group in the pro-am.
Conditions at the course were ideal and windless for the second day. The 6,835-yard Wailea Gold Course on Maui island runs along the base of the dormant volcano Haleakala and has 93 white-sand bunkers.