I have it enabled on my 2013 Retina MacBook Pro, my Apple Watch is on the same wifi network, and bluetooth is enabled as well. When I wake up my Mac, it says “Unlocking with Apple Watch” for several seconds, then it times out and prompts me to enter my password. I don't receive any notification on my watch either. I tried disabling and re-enabling the feature, but that doesn’t have any effect. Any ideas?
In case the accepted answer doesn’t work for anyone, my problem was due to Wi-Fi and/or Bluetooth taking too long to wake up on my Late-2013 iMac. I don't want it to sleep anyway, but Sierra toggled that back on.
In → System Preferences → Energy Saver, I enabled Prevent this computer from sleeping automatically when the display is off.
I'm not sure if there is a problem causing this delay on my iMac specifically, but it now unlocks instantly upon wake.