diff --git a/.vscode/settings.json b/.vscode/settings.json
index 0809508abc..7068a32abc 100644
--- a/.vscode/settings.json
+++ b/.vscode/settings.json
@@ -10,7 +10,8 @@
     "docs/spec.html": true,
     "common/config/rush/pnpm-lock.yaml": true,
     "**/node_modules/**": true,
-    "packages/website/versioned_docs/**": true
+    "packages/website/versioned_docs/**": true,
+    "packages/samples/scratch/**": false // Those files are in gitignore but we still want to search for them
   },
   "files.exclude": {
     "**/common/temp/**": true,
diff --git a/common/changes/@typespec/compiler/fix-playground-lsp_2023-10-03-15-56.json b/common/changes/@typespec/compiler/fix-playground-lsp_2023-10-03-15-56.json
new file mode 100644
index 0000000000..5945164bd2
--- /dev/null
+++ b/common/changes/@typespec/compiler/fix-playground-lsp_2023-10-03-15-56.json
@@ -0,0 +1,10 @@
+{
+  "changes": [
+    {
+      "packageName": "@typespec/compiler",
+      "comment": "",
+      "type": "none"
+    }
+  ],
+  "packageName": "@typespec/compiler"
+}
\ No newline at end of file
diff --git a/packages/compiler/src/config/config-to-options.ts b/packages/compiler/src/config/config-to-options.ts
index f95a4e76d4..5ad6c58c54 100644
--- a/packages/compiler/src/config/config-to-options.ts
+++ b/packages/compiler/src/config/config-to-options.ts
@@ -15,14 +15,13 @@ export interface ResolveCompilerOptionsOptions extends ConfigToOptionsOptions {
 }
 
 export interface ConfigToOptionsOptions {
-  /** Current working directory. This will be used to interpolate `{cwd}` in the config.
-   * @default to `process.cwd()`
+  /**
+   * Current working directory. This will be used to interpolate `{cwd}` in the config.
    */
-  cwd?: string;
+  cwd: string;
 
   /**
    * Environment variables.
-   * @default process.env
    */
   env?: Record<string, string | undefined>;
 
@@ -74,7 +73,7 @@ export async function resolveCompilerOptions(
  * @returns
  */
 export function resolveOptionsFromConfig(config: TypeSpecConfig, options: ConfigToOptionsOptions) {
-  const cwd = normalizePath(options.cwd ?? process.cwd());
+  const cwd = normalizePath(options.cwd);
   const diagnostics = createDiagnosticCollector();
 
   const configWithOverrides: TypeSpecConfig = {
@@ -86,7 +85,7 @@ export function resolveOptionsFromConfig(config: TypeSpecConfig, options: Config
     expandConfigVariables(configWithOverrides, {
       cwd,
       outputDir: options.overrides?.outputDir,
-      env: options.env ?? process.env,
+      env: options.env ?? {},
       args: options.args,
     })
   );
diff --git a/packages/compiler/src/server/serverlib.ts b/packages/compiler/src/server/serverlib.ts
index de6b6f6612..8b25ab671f 100644
--- a/packages/compiler/src/server/serverlib.ts
+++ b/packages/compiler/src/server/serverlib.ts
@@ -391,7 +391,7 @@ export function createServer(host: ServerHost): Server {
     const mainFile = await getMainFileForDocument(path);
     const config = await getConfig(mainFile);
 
-    const [optionsFromConfig, _] = resolveOptionsFromConfig(config, {});
+    const [optionsFromConfig, _] = resolveOptionsFromConfig(config, { cwd: path });
     const options: CompilerOptions = {
       ...optionsFromConfig,
       ...serverOptions,
diff --git a/packages/compiler/test/config/resolve-compiler-option.test.ts b/packages/compiler/test/config/resolve-compiler-option.test.ts
index b42c133dfd..c05c19e848 100644
--- a/packages/compiler/test/config/resolve-compiler-option.test.ts
+++ b/packages/compiler/test/config/resolve-compiler-option.test.ts
@@ -3,7 +3,7 @@ import { dirname } from "path";
 import { fileURLToPath } from "url";
 import { resolveCompilerOptions } from "../../src/config/index.js";
 import { NodeHost } from "../../src/core/node-host.js";
-import { resolvePath } from "../../src/index.js";
+import { normalizePath, resolvePath } from "../../src/index.js";
 import { expectDiagnosticEmpty, expectDiagnostics } from "../../src/testing/expect.js";
 
 const scenarioRoot = resolvePath(
@@ -17,6 +17,7 @@ describe("compiler: resolve compiler options", () => {
     const resolveOptions = async (path: string) => {
       const fullPath = resolvePath(scenarioRoot, path);
       return await resolveCompilerOptions(NodeHost, {
+        cwd: normalizePath(process.cwd()),
         entrypoint: fullPath, // not really used here
         configPath: fullPath,
       });
diff --git a/packages/samples/src/sample-snapshot-testing.ts b/packages/samples/src/sample-snapshot-testing.ts
index 352567bafe..aff140112b 100644
--- a/packages/samples/src/sample-snapshot-testing.ts
+++ b/packages/samples/src/sample-snapshot-testing.ts
@@ -95,6 +95,7 @@ function defineSampleSnaphotTest(
       overrides.emit = config.emit;
     }
     const [options, diagnostics] = await resolveCompilerOptions(host, {
+      cwd: process.cwd(),
       entrypoint: sample.fullPath,
       overrides,
     });