Watts will be transformed into Diana, Princess of Wales in filmmaker Oliver Hirschbiegel's upcoming drama Caught In Flight.
The film will tell the story of the late royal's personal search for happiness during the last two years of her life before she died in a car crash in Paris in 1997.
Watts, who was born in Kent but moved to Australia when she was 14, admits she feels honoured to play the British icon.
She says: "(It's) an honour to be able to play this iconic role - Princess Diana was loved across the world, and I look forward to rising to the challenge of playing her on screen."
And Hirschbiegel has praised Watts' acting, insisting it will embody "the warmth, humanity and empathy of such a global icon as Princess Diana".
Production is set to begin later this year.