@Daniel Odess makes some very valid points that you need to take into consideration.

The option fee is is just a payment as consideration for the Option to purchase. 

Or also another consideration was a buyer not taking a commission, making that $88k a higher net price than 97% of $90k which would be $87,300 net.

.* Tenants pay a NON-Refundable Option Consideration Fee in order to receive that option.

Taxes are another loss that needs to be taken into consideration. 

about the condition of the property, if it truly is this much of a "steal", and likely hesitate to pull the trigger. 2) Take a risk on a property in the city near me (cheap prices, high turnover, poor schools, low income), which is not a great city for real estate, that I can buy entirely using my HELOC.

should this earnest money in this case be solely my fee or should it include other considerations?

Tough margins, especially after taking into consideration periodic and major repairs.  

.* Tenants pay a NON-Refundable Option Consideration Fee in order to receive that option.

For and in consideration of the Option Fee payable to Optionor as set forth herein, Optionor does hereby grant to Optionee the exclusive right and Option ("Option") to purchase the premises (land and improvements), upon the terms and conditions as set forth herein.