Hmm. I seem to recall a similar situation in the '90s, when a popular maker of consumer electronics was facing total destruction against a rising competitor. They had a similar combination of a popular but graying line of products, and a newer, flashier, but (at that point) uncompetitive line. Their choice?

They went with option #1. For years (at least five years, I would say) they held the line, and indeed bled money and laid off lots of folks. They dropped the old line of products and doubled down on the new one, experimenting with many different (and ultimately failed) permutations, until finally they were able to hire a manager who turned things around.

This company, of course, was Apple...