Option 1, obviously, because it's bad-ass, though it begs a couple questions. What about boss battles where you're forced to lose but it still counts as a win and progresses the story? Do you have to go through those? Or would you fight them the time that you actually defeat that boss? Also, I'd be kind of screwed when it got to the Metal Slug series and certain shmups, a lot of those bosses I've found pretty impossible to beat without losing some lives and continues. Are quarters in the machine considered "equipment"? Also the whole keeping your current physical capabilities kind of grinds some to a halt, Muramasa, for one, because people can't friggin jump that high or do that stuff with a sword, Halo, with the armor, like people have been saying, or... any of the King of Fighters bosses?
Though there definitely would be some fun fights to go through, like Custom Robo (no pain, just mind stress, except for the illegal part fights), Persona (friendship is equipment too, right?), Pokemon, No More Heroes (rather doable too, Travis wins with little strength and awesome beam katana), Viewtiful Joe (V-Watch, action hero fighting, awesome) the Tales series and the Megaman bosses (so long as you were able to choose the order you beat them in). And it's not like many games I've played have had very painful deaths, they seem rather quick. So yeah, option 1.
... wait would the Yoshi's Island bosses involve strapping a baby to my back, eating enemies, pooping out eggs and throwing them at large creepy cartoony monsters? Screw that, I take Option 2.