Changing research area and ArXiv
I'd recommend your second option. As for being embarrassed by your old paper, you could alleviate the problem by adding, either to the arXiv's comment field  or to the paper itself, something like "This paper is a report on an undergraduate research project and there is no plan to publish it."  (You might also point out explicitly the  change in the spelling of your name, so that people aren't confused by it.)