My two cents is option number 2 as well.
However, I'm am curious why you will not permit training mode. If you're concerned about people switching up teams--it doesn't happen often, and the opponent will always keep an eye on it since he can potentially DQ someone. If it's for some other entire different reason then please enlighten me.
Training mode allows swapping players in much much faster.
At AI and AA, we used to do Rally mode, but what happened was eventually it'll say Game Over and you waste like another 60 seconds waiting for it to restart, if the challenger doesn't push start (or I can't remember what was the conditions). Free play + Training mode ensure that once the match was over the next to can sit down immediately and choose the next characters.
On a related note, personally I think there's nothing wrong with choosing different characters even if you win. I understand the reasoning behind why people want to be able to counter pick, but to me, it's a tournament. You have to beat your opponent no matter who they choose--but I'm cool with not changing characters.