The 25-year-old, born in Cowbridge, previously played for Plymouth Albion in the RFU Championship while he completed his studies. He made 47 appearances for Albion and was also part of the Wales Sevens set-up.
Watts-Jones moved to Blues in 2012 and has already made 25 appearances for the region in all competitions.
Director of Rugby Phil Davies said: "I'm delighted that Rory has re-signed for the Blues. He came into the senior set-up at Blues two years ago and has really taken his opportunity.
"Over the last few years he has progressed and has represented us in the RaboDirect PRO12, LV=Cup and Heineken Cup. He has been particularly impressive in Europe and was outstanding in the two games with Glasgow this season.
"I'm really pleased that he has committed to a long-term deal and I'm sure he will only get better in the years to come and continue to be a key part of our squad."
Watts-Jones added: "I'm very grateful to have the contract offer from Blues and accept it. Phil (Davies) is a loyal man and he has shown his great faith in me; I want to repay that with my performances.
"This season I feel I have stepped up and looked to take my chance in the first team. I'm a local boy from the region and there is nowhere else I would want to play my rugby.
"Obviously I want to play every single week and you have to really push yourself here. The talent in the back row is clear and while we are very close and get on well the competition is fierce.
"You want to be pushing each other and striving to get better. I like that environment and feel it can only make you a better player."