Ranieri was in the opponents' dugout for the first time since guiding the Foxes to the 2015-16 Premier League title and received a great reception from the home fans.
But in a chaotic and thrilling game played in blizzard conditions, his current side played a big part in their own downfall.
There looked to be no danger when Jonny Evans launched a free-kick forward, but William Ekong ducked under the ball and that allowed James Maddison to fire the 16th-minute opener past Daniel Bachmann.
Watford were gifted a chance to equalise in the 30th minute when Wilfred Ndidi clumsily chopped down Emmanuel Dennis and Joshua King fired his penalty into the top corner.
But the hosts retook the lead four minutes later with an unmarked Vardy glancing a header in from Maddison's corner. The pair combined again just before half-time with Vardy lifting a fine finish for his second and Leicester's third goal.
Dennis then dispossessed Timothy Castagne and calmly finished to make it 3-2 in the 61st minute, but the hosts quickly restored their two-goal advantage when Harvey Barnes set up Ademola Lookman for a close-range tap-in.
The victory takes Leicester up from 13th into ninth, while Watford remain 16th, four points above the relegation zone.
Later, Vardy said: "It is different [the weather]. You see with the ref having to stop it. These are things you have to deal with. You have to stay professional and we did that. At one point their keeper was trying to get it called off with the ref. But pitches have the undersoil heating and we weren't worried."
"We know when Madders [James Maddison] gets on the ball he has that creativity. It is about making the runs for him.
"It was a massive win. We got a good win on Thursday and we want to keep that momentum going. Games come thick and fast now."
On Claudio Ranieri's return, he added: "He got the reception the fans wanted to give him. We knew it was down to business on the pitch, though, and we wanted the win."
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