Reject a paper based on relevant but pointless research direction

Generally, as a reviewer, you are being asked for your opinion of the paper's correctness and its significance (importance, level of interest, etc). Evidently in this case you think the results are not significant or interesting enough to publish in this journal, so you should say so in your review. If possible, you should explain why you think so: the authors don't give any compelling applications, the results are only a marginal improvement on what's known, etc.

This isn't reason to decline the review. Thinking the paper is uninteresting isn't "prejudice".

If the editors don't agree with your assessment, they are free to disregard it and publish the paper anyway. But you do have a responsibility to give your honest opinion.

In fact, I would suggest that you evaluate the paper's interest before you start to carefully check its correctness. If you believe it's not significant enough to publish, even if correct, then you can so inform the editors and save yourself the time.

There are some exceptions, where the editors may only be interested in whether you believe the paper is correct. Perhaps they are already convinced it is sufficiently important (from their own opinions or other reviewers), or perhaps "importance" isn't a criterion for publication in this journal (e.g. PLOS One). If that's the case, then the review invitation should make this clear; otherwise, do consider the paper's importance as part of your review.

tl;dr: Let the paper try and convince you it's not pointless; if it hasn't, you may judge it harshly.

Referring to your three options:

Decline the review because you are prejudiced and unable to produce a fair review.

You're not prejudiced against the specific paper or specific author, you have an opinion regarding the significance of such papers. But - do make sure you're not pre-judging a specific paper because you've disliked existing ones which are somewhere between theory and practice.

Well, the paper is correct, isn't it? Judge exclusively by the content.

You're "spoiling" this answer by adding an irrelevant rhetorical question. We're talking about relevance and significance, not correctness. Always judge by the content; but - the content must include an argument for significance and relevance if those are not immediately apparent. For that, context is significant.

The editor has asked for your opinion and you think that the paper should not be published. Say so: "It is correct but this line of research is pointless. Yes, I know that there are hundreds of papers within this line, but those are not my business and I am currently reviewing this paper".

Don't say that until you've read the paper and have not been otherwise convinced. Also, again, the "correctness" is not the issue.

The bottom line is summarized in the tl;dr above.

PS - A paper may have a very interesting method to prove a not-very-useful result, and that may be an independent reason to accept.

I would, and have, chosen option 3. However, I phrase it differently. Make your point using neutral terms, so the focus is on your argument rather than your evaluation. That is useful to the editor, regardless of whether (s)he agrees with your points or not. A professional disagreement is no reason to be blacklisted.