* When you say sand the cylinder you mean a sheet of sandpaper and some elbow grease? No special equipment? Wet/Dry?

It doesn't really matter because you are only going to sand enough it break the glaze on the cylinder.
A sheet of sand paper folded in 4ths works

* I'll have to look into the glass bead peening for the piston - not sure if it's available locally. What would be a reasonable price for this?

I's say $5.00 maybe $10.00 at the most. Most automotive machine shops have one.

* When pricing new pistons I came across some aftermarket cylinder/piston kits on EBay and Woodland International. They have NiSil cyilnders and Moly coated pistons. They run from $100-120 USD. Does anyone have any experience with these. i.e. how do they compare with the OEM parts which seem to run about $200 USD?

Stihl parts are really over priced. Here in the States you can only get parts from a dealership.
Check out the eBay sellers rateing. I would guess their parts would work out nicely.

* I haven't tackled removing the clutch assembly yet. Are they LH threaded?
If I had to guess I'd say Left Hand threads. It's been 15 years since I worked on one.

The cylinder didn't look that bad. I even blew up the picture. You could probally get by with just a piston.

When you LIGHTLY sand the cylinder,
Hold even pressure against the wall and rotate the cylinder back and forth while rotating it all the way around.
Just enough to get rid of some of the marks on the wall.
Then reassess the condition of the cylinder.
A new picture would be nice.

New rings from Bowman will make a big difference in the engine, even if every thing is new.