The correct answer depends on the field and local customs. In Computer Science, your first citation style  is used. In older papers, people used more informative abbreviations [LS94a]. In Germany in times of old, and still in the humanities, you could put the citation in a foot-note. Since the paper steered the project, you can give them full credit by mentioning them in the text. I think that is what you are proposing in your first point.
In 2001, Stanley Kubrick and Arthur Clarke reported the finding of an obelisk on the surface of the Moon. They found that strong gamma radiation prevented a closer examination, but that by applying a spray of a Borox-Cadmium solution, this problem could be overcome .
In the humanities, you would indeed cite a long passage by using block-quotes and give the original and a literal translation. This is because mis-interpretation of the author's message is more likely. I have not seen this in the Sciences and would only expect this style to be used when a conclusion is being disputed.
If you want to follow local customs, just look at samples of theses (including doctoral theses) in the Library or ask your guide for advise. That is what they are for. You might also be overthinking this and should just go with your gut-feeling. Presumably, you will receive feed-back before you submit the final version for the defense (if there is one.)