I don't understand what you're saying:
However this option only allows guest login. Guest first has to have an account, correct?
guest and login are two different antinomic concepts.
Logging in before checking out means that you have to enter the username and password of your user account on the website before checking out.
Guest checkout means that you don't already have a user account and that you don't want one on the website. You just enter your email address and shipping address in order to be able to checkout.
Registering before checking out means that you have to enter the username and password you want for your user account plus your shipping address in order to be able to checkout.
So no, guest don't need to first have an account, and this option doesn't allow "guest login".
So in short, since I don't know what you're trying to achieve I cannot tell you what to do.
The way you have it configured is like a normal login/registration checkout. If you want a guest checkout, you would have to set the "registration" option to "guest". But maybe that's not what you actually want to do ?