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I need to develop an application to run on a recent iPod touch. Xcode does not have iPod as an option for device (only iPhone or iPad). Likewise, there are no simulators for iPod touch. I've read you can just select iPhone as the device and simulator but I am skeptical that will create an app I can deploy to a iPod. I've also read you can use iPod's to test iPhone apps but this is not my scenario. Is writing apps for the iPod touch with Xcode a bad idea?
Yes, you can develop for iPod touch using Xcode, just as you do for iPhone and iPad. (There is in fact no other way to develop apps for iPod touch.)
The differences between an iOS Simulator and any physical iOS device are much more significant than those between an iPhone and an iPod touch. (No simulator configuration has telephony capability, for example.) If you want to target the 5th- and 6th-generation iPod touch screen size when testing in Simulator, just choose the iPhone 5, iPhone 5s, or iPhone SE simulator, as those iPhone models have the same screen size as the last two iPod touch models.
When you choose an app template upon starting a new project in Xcode, the choice it offers you between "iPhone", "iPad", and "Universal" really means "phone form-factor" vs "tablet form-factor" vs "support both". If you choose iPhone or Universal, you'll get template UI layouts that support a phone-sized screen (or rather, various phone-sized screens, including 4-inch for iPhone 5/5s/SE, 4.7-inch for iPhone 6/6s/7, and 5.5-inch for iPhone 6/6s/7 Plus).