Watches were added in [Halloween Update] on September 10th, 2010. They are created by using one Redstone and four Gold Ingots (see formation below).
Biendeo says, "The watch works like the compass, in the sense that you cannot use it, but its image changes depending on the circumstance. What I think is that the watch displays where the sun or moon's position is in relation to the horizon. So, say it is midday, the sun will appear directly above the middle point of the compass. If night is just coming over the horizon, then the dark area of the compass will appear, and so on.
The watch crafting recipe is as follows: