Afaik they can not inhale through gill splits, water flows only in through the mouth and out through the gills. So it should be 2, but the smoke would be coming out from the gills.

Even with gills, the mouth is where they breath in

I don't think you can smoke underwater

Are the gills like ears...?

2. I saw it in a movie

In the mouth, obviously, the most important part of wrangling the monsters in the darkness of existentialism is to do it with panache, and the second option is cooler.

The first option is like tucking a cig behind your ear. A viable backup.

All philosophy is inherently existential in that something must exist to define philosophy to begin with.

Takes a drag of my cigarette and blows it out my gills

Diver Dan proved it is number 2

In the butt I say.