Win 7 will give minor improvement in responsiveness since it demands less resources than Win Vista. A SSD can improve the amount of time Windows takes to load as well as programs and large files by a few seconds. It does not improve the performance of the CPU.
Option 1 is the easy and most logical choice if you are looking for better performance.
700 on upgrades is way too much, 2 gig of RAM and an upgrade to 7 should speed things up, but the CPU and video card will still be the slowest part of the system. A faster regular hard-drive may help, a newer 7200 RPM one, or a smaller cheaper SSD.
If you can upgrade for about $200, maybe worth it if you are looking at laptops for $1,000 to replace it. A $500-600 new laptop will outperform any T61 now.
In what area of performance increase are you looking at?
I have a T61 which has done very well for me. One thing I like is the more square dimension of the display.
I upgraded by installing a 40gb Intel X25-V SSD, and the performance improvement was remarkable.
No doubt, adding ram will be good, particularly if you will be upgrading to W7-64 bit. Get the upgrade version, not oem. Upgrade gives you both 32 and 64 bit dvd's, MS support, and because it is considered retail, you can move it to another pc if you ever abandon the laptop. If you have a second pc that you want a W7 upgrade for, look for the family pack which gives you 3 licenses for about $135.
I don't think you can buy a 500gb ssd for $700. But, if you need 500gb capacity, look at the newly announced Seagate momentus XT hybrid drive. It includes a SSD cache that makes it quicker than any conventional hard drive.