JAKARTA, Indonesia—A smoldering volcano is delivering the resort island of Bali its worst holiday season in years, with hotels at half their usual occupancy levels and tourists canceling plans amid eruption fears.

Representatives from two five-star hotels in Nusa Dua, a high-end coastal enclave, said occupancy rates are about 20% of capacity and bookings for Christmas and New Year’s Eve are down by roughly half.

Bali...