unlock with apple watch is grayed out?

Do you meet the requirements?

• An iPhone that uses Face ID (iPhone X or later) and has iOS 14.5 or later
• An Apple Watch Series 3 or later with watchOS 7.4 or later

See https://support.apple.com/en-us/HT212208

Watch won't unlock phone.

If you're not on 7.4 that would explain the problem.

I had this problem, but when I restarted both my iPhone XR and the Apple Watch 3, the problem cleared.