First-round leader Craig Stadler shot a 2-under 69 and Loren Roberts, who made his Champions Tour debut last week at Royal Aberdeen, carded a 4-under 67 to match Watson at 9-under-par 133 at NCR Country Club.
Wayne Levi shot a 4-under 67 on Friday and is alone in fourth place at minus-7.
Raymond Floyd, who won the PGA Championship at NCR in 1969, posted a 4- under 67 and is tied for fifth with Des Smyth, who lost in a playoff to Watson last week at the Senior British Open. Smyth carded a 5-under 66 and joined Floyd at 6-under-par 136.
Watson, who collected his second Senior British Open win last week, started on the back nine Friday and collected his first birdie at the 11th when he hit his approach to a foot. His next birdie also was from a foot at the par-3 15th as a result of a spectacular 4-iron.
He saved some beautiful pars to close his opening nine, including a tough two- putt from short and right of the hole at 16. Watson also saved four from a bunker at the last to make the turn at 3-under 32.
At the par-4 third, Watson hit an 8-iron 20 feet right of the hole and converted the breaking birdie try. He recorded an odd par at the par-4 fifth when he reached in two, but putted off the green with his birdie putt. Watson rolled in a 20-footer from off the green for his par.
He took advantage of the back-to-back par-5s at five and six. On the fifth, Watson just missed the green with his second, but pitched to 5 feet and ran home the putt. He hit an awful 4-wood for his second at six, but lagged a 70-footer inside a foot for the tap-in birdie.
Watson hit an 8-iron to a foot to set up his third birdie in a row at the seventh. He parred No. 8, but ran into trouble at the ninth thanks to a horrible drive. Watson never recovered, bogeying the hole, but still matched Friday's lowest round.
'It was kind of a hot and cold day,' admitted Watson. 'It was very hot, as I hit the ball within a foot of the hole four times today. But my play off the tee was not very good.'
Stadler, who finished fourth last week, wasted little time in breaking into red figures on Friday. He hit a 9-iron to 5 feet at the first to set up birdie.
He missed the fairway with a 3-wood at the fourth and was forced to pitch into the short grass. Stadler could not save par, then traded one birdie and bogey on the remainder of his front nine to make the turn at even-par 36.
At the 202-yard, par-3 13th, Stadler hit a 4-iron to 15 feet and made the birdie try. He closed his round with an interesting birdie. Stadler hit a 3-wood into the rough and was only able to advance his ball 45 feet from the hole. Stadler drained the long birdie putt to join the group in the lead.
On Thursday, Stadler matched the competitive course record at NCR with a 7-under 64. On Friday, Stadler thinks he played similarly, except for the flat stick.
'It probably played darn near identical to what it did yesterday afternoon. Breeze was about the same, the greens were same speed, as receptive,' said Stadler. 'I made some putts yesterday and I missed a lot today.'
Roberts, who played with Watson on Friday, birdied his first, the 10th, when he got up-and-down from a bunker. His ball plugged into a trap at the 13th and he could not save par. Roberts hit a 5-iron to 15 feet at the 18th to set up birdie and a 1-under 34 on his opening nine.
Roberts knocked a 7-iron to 6 feet at the third and the 50-year-old rolled in the birdie try. He collected back-to-back birdies when he ran home a 3-footer at the fourth. He laid up with his second at the par-5 sixth, but hit a wedge to 3 feet and holed the birdie putt to join the fray in the lead.
'I played really solid the last two days,' said Roberts, who will be one of Tom Lehman's assistant captains for next year's United States Ryder Cup team. 'But the key is that I've driven the ball well. Anybody who's put a low score up has driven the ball in the fairway.'
Tom Jenkins fired a 6-under 65 and is part of a group tied for seventh place. Bruce Summerhays (69), Mark McNulty (67) and D.A. Weibring (67) joined Jenkins at minus-5.
Greg Norman, who made his debut on the elder circuit last week when he missed the playoff by a stroke, carded a 1-under 70 on Friday. He shares 11th place with Allen Doyle, who posted a 4-under 67, at 4-under-par 138.
The 36-hole cut fell at 3-over-par 145 and among the notable players who will miss the weekend are: Jim Thorpe (146), Senior PGA Champion Mike Reid (146) and Fuzzy Zoeller (147).
Arnold Palmer shot a second-round, 10-over 81 and finished at plus-24. After the round, he announced that he was done with major championship golf.
'As far as trying to compete in a major championship such as the Open and other tournaments, this is it,' said Palmer, who won this title in 1981. 'I'm through doing that. I will not be doing it anymore.'