Where "Cover.jpg" is shown right now (textbox) on Tags(1) page...does that only apply to "copy to the same folder as the music file and name as:"?
Yes. If you want to keep all your files in one folder, and you don't want to embed, that's your only option. Click on the ... at the end of that box, it will give you the template creator pop-up.
So can the audio files remain in one folder and the album cover images get directed to a different folder using a naming convention as you suggested? Is that what soundtrack pictures location is for (folder remains empty so far)? And would I need to check any of the 3 checkboxes for artwork storage options for this approach and if so which one?
Yes, you need to check the third artwork storage option if you're going to go this route. You could try sending the artwork to a subfolder using the template (ie Album Art\<Album Artist> - <Album>.jpg); I don't know if will recognize that or not. If you don't include a folder structure, it will just go in the same folder as your audio files.
The Artist Pictures location and Soundtrack Pictures location are irrelevant for Album Art. Those are for the rotating art in the compact player, etc.