Setting up an Airport Express with a Time Capsule

Merry Christmas! I received a new Airport Express for Christmas. My intention is to use it to stream music to my stereo. I have to admit that setting the AE up was not as simple as I had hoped it would be. I do have it working but I would like someone with more experience in this area to validate what I have done.
My wife and I each have MacBooks and we have a Time Capsule as our base station in the den. I would like to use the AE to stream music to my stereo which is in the living room. I would also like the AE to act as a "booster" to my TC, which I think is called "Extending a wireless network".
Here are my questions concerning the settings I have used in Airport Utility:
In TC, under AirPort, and the Wireless tab, I have checked the box for "Allow this network to be extended". Is that necessary?
In AE, under Airport, and the Wireless tab, there are a number of choices in the pulldown for Wireless Mode. I know I do not want to "create a wireless network" since that is what my TC is for. But all three other choices seem valid for what I want to accomplish -- Participate in a WDS network, Join a wireless network, or Extend a wireless network. I chose Extend a wireless network. I also checked the box under Network Name that says, "Allow wireless clients". Are these settings correct?
Here's the problem I'm having with things set up as I described above. AirTunes works fine. But if we close either of the MacBooks (put them to sleep) and open them in the living room which is closer to the AE, we seem to lose internet connectivity. When we open a browser or click on a link, it starts to load but then freezes. If I then walk the MacBook into the den, closer to the TC and restart the Airport or put it to sleep and wake it, its fine. Also, if we work long enough in the living room closer to the AE, it will also loose connectivity. I can sit in the den near the TC without any dropping.
Any suggestions on what the proper Airport Utility settings should be for my TC and AE would be greatly appreciated.

Your biggest mistake is confusing signal strength with signal quality. The signal indicator indicates strength and nothing else. You need to be using iStumblr to look at SNR (Signal to noise ratio).

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