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The Hornets want to sign a left-back during the January transfer window and Kolasinac is on their list of targets.
The Bosnian has just over six months to run on his contract at Arsenal and he is set to leave for free in the summer.
Watford would be interested in signing Kolasinac on loan for the rest of the season, but Arsenal would need to subsidise his £100,000-a-week wages.
Any deal for the 28-year-old is in its early stages, with Watford still assessing which left-back they will look to sign next month.
The club have shown an interest in Hibernian teenager Josh Doig, but a deal for him is more likely to take place in the summer. Rangers left-back Borna Barisic is another reported target.
Kolasinac, meanwhile, is thought to be open to the idea of joining Watford and continuing to play in the Premier League.