How to rationalise the major product formed in a nucleophile promoted epoxide cleavage reaction?
Let's do this step by step and figure your questions out.
First, what a nucleophile needs is positive terminal in the compound.


The other carbon attached to oxygen is not as positive as the one where the attack has been done due to inductive effect of $\ce{-CH2}$ adjacent to it. The product (1) is not formed as there is no source providing $\ce{H+}$ to form alcohol. If possible a very small amount  may be formed by $\ce{H+}$ extraction from $\ce{EtO-}$. Next the intramolecular nucleophilic substitution takes place. 



I do agree that product (2) is formed, but as a minor product. Here what we observe is that there is neighboring group participation in the mechanism. Generally these neighboring groups increase the rate of the reaction by switching on abilities like dipole in the bond. Whenever we observe compounds with such epoxides or sometimes even alcohols, we better think of such consequences which can help us predict the product.