Well thought-out question!
I'd go with Method 2, but that's more of a personal preference. To me, the Method 2 Cons aren't much of an issue. I don't see the host OS outgrowing its 5-10GB partition, unless you start installing extra stuff on it, which you really shouldn't. For the sake of simplicity and security, the host OS really should be a bare minimal install, not running anything except the bare minimum needed for administration (e.g. sshd).
The Method 1 Cons aren't really an issue either, IMO. I don't think there would be any extra security risk, since if a rooted VM is somehow able to break out of its partition and infect/damage other partitions, having the host OS on a separate VG might not make any difference. The other two Cons are not something I can speak to from direct experience, but I my gut says that CentOS, LVM, and libvirt are flexible and robust enough not to worry about them.
EDIT - Response to Update 1
These days, the performance hit of virtualization is very low, especially using processors with built in support for it, so I don't think moving a service from a guest VM into the host OS would ever be worth doing. You might get a 10% speed boost by running on the "bare metal", but you would lose the benefits of having a small, tight, secure host OS, and potentially impact the stability of the whole server. Not worth it, IMO.
In light of this, I would still favour Method 2.
Response to Update 2
It seems that the particular way that libvirt assumes storage is layed out is yet another point in favour Method 2. My recommendation is: go with Method 2.
Yes, you can create an LVM snapshot volume and convert it with qemu-img:
lvcreate -L592M -s -n myvolume /dev/myvg/myvolume_snapshot
qemu-img convert /dev/myvg/myvolume_snapshot -O vmdk myvolume.vmdk
Best Answer
VMware converter can migrate from any source machine regardless of the source type. (virtual/physical/KVM/Hyper-V) The only trouble is VMware converter can't migrate software RAID or LVM. So the solution for this is to create a skeleton server with the bare minimum of the source machine and push everything with the tar command from the source server.
I had to use this solution, when I was migrating quite a few racks bare metal server to VMware and some had softraid or LVM installed.
Steps to follow for this:
1: Create your target vm box
2: Install a minimum version of the same system that your source has (network, ssh server and tar must be available)
3: Create a list of directorys we don't want to include
boot proc dev sys etc/fstab etc/lvm etc/blkid mnt/yourexternalhdd
save it under /tmp/nocopy
4: Take a snapshot of your target in case something goes wrong
5: SSH to your source and as root: cd /; tar -zcvpf - -X /tmp/nocopy * |ssh target "cd /; tar -zxvpf - --numeric-owner" 6: Reset target.
E.G.:
tar -zcvpf - -X /tmp/nocopy * | ssh root@10.0.4.158 "cd /; tar -zxvpf - --numeric-owner"