Jim,
I really think that you'll be happy with that Onkyo. To answer your questions:
1. Yes, the optical connection. I couldn't remember which type of connection that player had (optical and/or coax), but I just checked the manual and it is an optical.
2. I would think that it would be kind of weird to be looking in front of you at the screen and to hear people talking behind you. I like to have the dialogue seem as if it's coming from the screen. That's why I'd think that speakers up front would be better than having them behind you. As an added bonus, you don't need to run wires across the room.
If that Onkyo is any where near as good as my three-year-old Pioneer at converting the digital bitstream for Dolby Digital into two-channel stereo, you should be able to make out the sounds just fine. I would expect it to be as good.