I think the warmachine status for the epic avatar is not really anything about it's size but more to do with its resilience (and unnatural nature).
I think it can be all 3. In my reading of the Emperor is that in people's perception he can be be any size he wants to be, due to his psychic abilities. His combat abilities are also psychic based (ie he is amazing because of his psychic abilities, not because he in any way rivals the basic strength of a Space Marine, for example). An Avatar, being a daemon-like being, and so presumably at least partially fuelled by the warp and psychic power, also doesn't need to be massive to be deadly. And also may be able to appear different sizes at different times. When fighting against normal people he doesn't need to be massive (but could be). When fighting a daemon or something similar, we are talking about two at least partially non-"real" beings fighting each other. The physical events a person would see don't necessarily have any bearing on what is actually going on. The apparent physical struggle could just be a representation of a psychic struggle between the two beings, and if that is true (no evidence for this... me just waffling) then both beings can appear just as big as they need to be. Yes, the small original Avatar would look a bit strange breaking a keeper of secrets over his leg, but for that fight he may have appeared much bigger.
Game wise I think the current one metal is probably best... not daftly large, and not looking strangely small. A bit dated modelwise though.