The first reboot to recovery is Xionia, that is after I see the
/data/local/tmp/sh: permission denied
Is there anything else I should have done prior to starting?
I'm curious, do you have a /data/local/tmp directory on your installation?
I think the issue you are seeing might be related to your current install being CM7 and some directories might not be the same as stock, but that is just a working theory.
I think the quickest way to get everything working would be just to revert to ZVD using the update.zip, Root ZVD using Option A, then go through Option B, but I'm interested in figuring out what is going wrong with your current setup.
Basically when you choose Option B, Step A (install ZVJ recovery) at some point it pauses and tells you it is asking for root permissions. It caches your response by creating an suid root sh in /data/local/tmp
This is somehow failing and I'd need to figure out why. My first attempt is just to check if that directory exists on your setup, since you aren't on a stock derived system.