I did option 1 about 1.5 years ago. Built a cheap machine :
sempron 2400
5 250GB drives in software raid 5 array (~ 1 TB)
160 gb for boot and other misc
fans


I used a modded xbox running XBMC to strem this stuff.

If you would like to spend less money you can use a linksys nslu2 and two 500 gb usb drives. Transfer speed isnt great ~ 3mb/s . But that should be enough to stream a dvd for 1 user. DVD playback works ok with the nslu2 also.

A server is much more versatile, but also much more power usage.