This is one of the many mimetic words in the Japanese language, and it is commonly used in a daily life.
You can write this word in both Katakana ニコニコ and in Hiragana にこにこ.
We don't know the exact origin of this word, so it might be better just to give you the answer to this one!...
The answer is number 3 - smile ! 😊
To be more precise, this word is an adverb. It transforms into a verb adding the verb します (shi-masu).
Combination with the verb shi-masu
As with many mimetic words, you can put the verb します (shi-masu : to do) at the end to change it from an adverb, to the verb ニコニコします(niko niko shi-masu) « to smile ».
Instead of します (shi-masu)、the present continuous form しています (shite i-masu) indicated that this is an ongoing action or habit, and can be used to say that someone is « smiley » as well.
How is it used?
Let's see some examples:
あかちゃんはニコニコしました。Akachan wa niko niko shi-mashita.
The baby smiled. 😊
かのじょはいつもニコニコしています。Kanojo wa itsumo niko niko shite i-masu.
She is always smiley (She is always smiling). 😊
Similar word "niya niya"
There is an another similar expression ニヤニヤします (niya niya shi-masu). It has to do with « smiling » as well, but, just the use of "ya" instead of "ko" changes the nuance completely!
ニヤニヤ (niya niya) is a thin and silent smile used to express that someone is maybe plotting something. It's a rather shady kind of smile.
かれは「しらなかった？」といって、ニヤニヤしました。Kare wa « Shiranakatta ? » to itte, niya niya shi-mashita.
He smirked saying, « You didn't know that? » . 😏
Just a one-letter difference can completely change the meaning of a word, so be careful to use these appropriately!
So, don't ニヤニヤ (niya niya), just ニコニコ (niko niko) !