That is the option. Give it a try. I had the exact same problem, posted images, whether as attachments or hotlinked, were displaying as clickable thumbnails. When I turned that option to NO, the images displayed full size.
The reason it took me so long to fix the problem is that I didn't think it had anything to do with attachment settings either. I was mistaken.
EDIT: Also important...turn off the last setting on the page... Advanced Insert Image Popup - Enable... to display only the legacy dialog box when inserting an image. If not, vbulletin will download the image and store it locally and treat it like an attachment.
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