There's trouble in the Rainbow Sea, home of Bubby and many other peaceful people. An old monster named Krabo has cast an evil spell over the land. Only Bubby, with his ability to create magical rainbows, can stop Krabo and save the Rainbow Sea. In Rainbow Islands, you control Bubby on his quest to stop Krabo. Your power to create rainbows will help you climb obstacles and destroy enemies. There are seven levels for you to complete, each with its own level-ending boss. After you have defeated each boss and claimed the Rainbow Diamond for the stage you will have saved the Rainbow Sea from Krabo's treachery.

The European version released by Ocean in 1991 as "Rainbow Islands: The Story of Bubble Bobble 2" differs in level layouts, two-player alternating gameplay, and gameplay more similar to the arcade version than the Japan and USA NES ports.