Personally I'm somewhere between the first two. I like to be modest, but I've found my own style where I can be a little sexy too and still not cross any modesty lines I have for myself.
The people that kill me are the ones that show it all; the girls who wear shorts so short they're showing off their buttcheeks, skirts that are so short they actually show off their underwear, mesh shirts with nothing but a bra underneath. I don't think you need to dress like a nun, but come on. That's too extreme. For guys what gets me is wearing jeans around their knees. It makes me want to stop them and ask if they know just where that style came from because if they did, I don't know how they wouldn't be absolutely embarrassed to leave the house looking like that.
The other issue is that how you dress is how you are perceived. For a girl, if you dress that way you are thought to be a skank and 'easy'. For the guys, personally, I think you look completely retarded with your pants hanging halfway down your legs.
Sad as it is, people do judge you by how you look. It's almost impossible not to. I know I do it without even realizing a lot of the time and I hate it.
As for taking covering up to an extreme, yes I think there are people that do that too, but I'm not offended by that like I am with the other extreme. At least if you're covering it up I don't have to see it. A lot of times covering up in the extreme is either a religious thing or just makes the person feel more comfortable and there's absolutely nothing wrong with that in my mind.