To create it directly on the LinuxCoin drive,

boot from usb
sudo mount -t vfat /dev/sda1 /mnt
dd if=/dev/zero of=/mnt/live-rw bs=1M count=600
mkfs.ext3 -F /mnt/live-rw

In this example the 600 represents a 600MB file and /dev/sda1 is the name of the usb key

Hope that helps

Trip