I have done option #2 and it works really well…
You have two options:
- Encrypt the entire USB flash drive. However, you will not be able run TrueCrypt from the USB flash drive.
Note: Windows does not support multiple partitions on USB flash drives.
- Create a TrueCrypt file container on the USB flash drive (for information on how to do so, see the chapter Beginner’s Tutorial, in the TrueCrypt User Guide). If you leave enough space on the USB flash drive (choose an appropriate size for the TrueCrypt container), you will also be able to store TrueCrypt on the USB flash drive (along with the container – not in the container) and you will be able to run TrueCrypt from the USB flash drive (see also the chapter Portable Mode in the TrueCrypt User Guide).