Here is what I did. I installed Joomla 3.3.6, then installed K2 2.8.6. I made a few categories and an item as well.

I want to only show sub categories on the menu items for the main categories, but not the items.

I select "no" instead of yes, after save it just goes back to "yes".

This setting is disabled when you select a single category. That's why you see it to revert to "Yes". It's value is ignored when you select a single category. When you select more than one category it works fine.

You need to enable the "Catalog mode" option for the parent category to achieve this layout.

It looks like just enabling catalog mode on the k2 category and leaving the menu item alone did it, it works now.

I am curious though, why does the menu item require 2 categories. I tried it and it broke and showed nothing at all when going to the menu item and catalog mode seems to achieve the same desired effect and works well. Why not just have catalog mode and not the menu item option that doesn't seem to work well anyway?

The menu option is not actually intended for this functionality.
The include from items from children categories is more suitable for portal - ish sites that want to display items from one category.

Ah ok, thanks for the help

You 're welcome Ryan.