Yes you BO the sts as you go, but by slipping them instead of purling. Slipping each one with the yarn to the front makes a sturdier edge. To reverse the st I think it means to turn it so there's a twist in it. The 5 backward loops on the R needle are casting on sts over the bound off ones; however I'd do a cable cast on, it's firmer than the loop CO. Then 'work 3 more rows' just means to continue knitting for 3 more rows, no more holes.
Here's another explanation
for the BO that's used, it sounds like the method is the same for a buttonhole.