Based on what you have explained here, it is obvious that he knows he screwed up your engine. If he will fix it and make it right for the originally agreed upon $500, then let him fix it if you believe he is competent to find and install an engine. But that is a big chunk for him to eat. I would be surprised if he offers to do that, but if I were you, I wouldn't settle for anything less.
The problem here is that the car wasn't running when you took it in and there is no way for him to know the condition of the rest of the engine. For all he knows, you are trying to bamboozle him for a whole engine for the price of installing heads. You have to look at both sides.
I agree with sandrock that you should demand to see the damaged parts. You own them, they are your property. If I ever have someone else do work on my car, I keep the old parts and handle any core exchange myself.
1990 LE -wrong bumper