Option 2. whether lives are good or not depends on the game. for example, in old games, getting a game over was way scarier than getting one nowadays, because you'd have to start all over. however nowadays a lot of times they just feel unnecessary and the only thing that happens is a much longer and more tedious death. in games like mario 64 or galaxy for example, all a game over does is bring you back to the hubworld and you'd have to go back to the level you were trying to beat, which just makes game overs more of a nuisance than something you'd be scared of. i mean yeah, this would make you NOT wanna get a game over, which is kinda the point, but in that case, then why have them at all? i think mario odyssey did a great job in that department, as game overs are flat out removed. now you can try a hard sub area or something over and over without having to worry about the long game over and i dunno, respawning somewhere like the odyssey and THEN going back to the sub area you were trying to beat. in games like rpgs however, since it doesn't work on lives, losing all your health just means game over. at least in those games it makes sense to have a game over, simply indicating that you lost the battle.
now even when it comes to platformers, game overs can be implemented well as long as they exist for a reason, but a lot of times i think it would be better if they just didn't have them, as mario odyssey showed us what a mario platformer without lives is like.