you want option 3. I have AT&T DSL with a separate router, and it took me a couple hours to get it working because of this. Their explanation of the different options is partially incorrect - with Option 3, PPPoE *IS* used - just not on the DSL modem. Option 3 will let your router make the PPPoE connection.
Then, set your router to connect using PPPoE.
Your PPPoE username and password are given to you by AT&T - my username is my full @sbcglobal.net email address.
Extra Info
With either of the other two options, your router will act as a NAT firewall and DHCP server, and the modem will do the PPPoE connection. If you leave it on Option 1 and can connect with just plugging your computer in to the modem, you can also use your router in standard DHCP client mode. This may prove problematic if you ever run applications that need an inbound connection - you'll need to set up two incoming port rules (one on the DSL modem and one on your other router).
Also, if you opt for this avenue, you'll need to make sure that your router is set to give its DHCP clients IP addresses on a different subnet than the DSL modem gives your router - this is likely your problem.
hth, gl
These are the three options that the modem has, option 1 is selected right now
1: PPP is on the modem. This is the normal mode for this modem when connected to a single computer. In this mode, the PPP session is initiated from the modem. Gateways and routers should work in this mode but their configuration may have to be changed to do so (e.g., you may need to have the gateway/router IP address changed to 192.168.1.1).
2: PPP is on the computer. This mode is normally used if you need to run a PPPoE client on your PC. This mode can be used with a gateway or router which initiates a PPPoE session. To return to the DSL modem user interface you will need to directly connect your PC to the modem without any gateway or router between the modem and the PC.
3: Bridged Mode (PPPoE is not used). This mode must be used if you are connecting to a non-PPPoE network. Selecting this mode will cause the modem to automatically restart.