I'm shocked at the upvotes on answers describing #1 and #2 as equivalent. They aren't at all. Sending the user a short term link to change their password is the most convenient, most commonly used, and most secure approach that doesn't involve an out of band interaction (mail, text msg, etc.). A few reasons:
- Setting a temporary password via a forgot password link allows users to effectively change a user's password and lock a user out of their account if they know the user's login. With a link, the user simply knows someone is messing around and their access isn't impacted.
- The password reset link is only valid for a short period, so there's a very small window for an attacker to strike. And even if they did, the user would know because the reset link would no longer work if the attacker intercepted the link and used it to change the password. If the new assigned password isn't changed by the user immediately, the attacker who intercepted the password can quietly impersonate the user indefinitely. So the big difference is, while a hacker can intercept the reset password link email, if they use the link to change the user's password, the user will know something is wrong because the link won't work and they'll generate another password reset request.
- Easier to use - the user simply clicks a link in their email rather than typing a new random password you've generated.
And security questions often make a site less secure, not more - they're another attack vector and often the weakest link. I highly recommend reading The Web Application Hacker's Handbook for an excellent discussion on this topic.
