"Add sub-assembly from selection" is not available in my drop down menu.

The items you want to place in your new assembly need to be sequential in the assembly tree.  Move the part through the tree until they are all together - right now it looks like there is a bunch parts in the center of your selection that you do not want in the new sub assembly - they just need to be moved around.

Another way is to just grab a handful of the parts that are already sequential, make the sub assembly, then at the higher level assembly you can drag and drop them into the new sub-assembly.  Good luck!

Forgot to add - This is the option I beleive your looking for...

Click on "Customize Menu" at the end of the pop up window and then make sure "Form New Sub-Assembly Here" is checked.

You also need to make sure that you've not selected any sub-assembly component i.e. all components should be independent  or you should select the complete sub-assembly instead of it's child component.