First of all thank you for a good patient post

Without changing the general logic, I see a couple of changes:
1) Uses the "output to PINx" to toggle pins feature.
2) jump to your Y reload instead of including it twice.
3) replace doubled no-ops with two-cycle no-ops like "rjmp ."
Okay, let me see if I understand correctly:
1) As far as I could gather, the PINx is the "Input Pins Address", which I figured to mean that it was for input, not output? So when I do SBI to PINB, it actually toggles HIGH/LOW, rather than just setting HIGH?
2) I gather, that you refer to me reloading Z twice? I know it is rather anal (1 lousy ms), but I wanted to try my hand at cycle-counting, which is more of an academic exercise. But as you said, the precision is not really necessary for this example.
3) Ah, so you can use the rjmp without actually jumping anywhere to get two cycles in one command word. Nice little trick!
Using extra nops in your top-level Delay routine (at enter and exit, especially) is silly. You're talking 125ns out of a human-visible 500ms...
Likewise the double no-op in the outer delay loop.
Again, yes I know. It does not REALLY matter.
Likewise, and as implied by your comments, I'd be inclined to make the inner loop longer so that the outer loop would be useful with a single-byte counter (1/50th second or something.) Assuming you don't go to a timer-based approach.
Ah, this was my first idea. I really wanted to use that. But then I could not use the function to actually set an arbitrary number of milliseconds for the delay, right?
As someone pointed out, you're using some RAM for the stack. It's a good thing you used one of the AVRs that initializes the SP for you.
Okay, this I had a hard time understanding, so I have to read a bit. Is it only when I do subroutines (RCALL / RET) - where RCALL PUSHes the position to the stack and RET POPs it back? So the program as it is now uses 2 byte (1 16bit word) of memory?
So if I should ever encounter a (n AVR) processor, I should stay away from subroutines (or be really clever)?
Again thank you (all of you) for the help.