I would have to support the first option. As a rule of thumb, it is generally considered "good practice" to have all of the declarations for a block of code at the top, along with a concise description of any declarations that may add to readibility.
One other thing to consider is the size (in lines of code) of each subroutine. In my early days as a Cobol programmer, the site standards specified that a subroutine should not be longer than two pages of standard 66 line fanfold printout. That way, you could see the complete subroutine at a single opening of the printout binder. Now, we have long since moved beyond filing out program listings in binders of 132 x 66 sized listings, but the idea still has validity - you should be able to take in the who subroutine at a single reading. Hence, make each routine do a single task - no side effects.
