Chiming in with my experience dealing with this…
I ended up with the same solution as you, Claire. I tried the “both” thing (using your option 1, two versions of iTerm). Some of my projects were in the M1 setup and I switched them over to Rosetta as-needed if I ran into M1 compatibility issues. I was able to mostly get it to work although there were a lot of hiccups, especially around my .zshrc/.bashrc files.
After a few weeks I decided it was just too annoying/confusing/complex. I do everything w a Rosetta terminal now and basically just pretend I’m not on an M1. I have the base Macbook Air model and everything feels pretty snappy despite being in the emulator.