I'm an artist so there are often a lot of images in my posts, and I've just started using Chateau and have been following TimeThief's advice from her blog. I'm currently in the process of pasting the HTML code for each image, into each relevant post's excerpt box. It does work well, but it is very time consuming and I do agree that there should be some way for the image to show without one having to do all this work oneself. It's a bit crazy really that this was overlooked as there are so many bloggers on wordpress.com who are artists or photographers or otherwise involved with imagery. Even 'ordinary' bloggers who are doing things like the 365 project in which they post a pic a day... crazy!
For myself, I don't mind the 'continue reading' link because a lot of people when seeing just an image thumbnail don't realise that there's a larger version for them to see, unless they're given a clue of some sort!
An alternative, by the way, is to make sure that the image opens in a new window then the image will become a link to that separate page - and people will be able to see its largest view. Myself, I prefer not to do this, so I make sure it isn't there. But it might be an option for you.
Oh and one of the excerpts that I went to didn't have the 'read more' link... I think it was a post in which I'd not posted any text at all? Not sure about that though. It's probably worth experimenting.