So let me start by explaining what the code that you've posted above does. The entire block of code generates one link: there are a bunch of if statements that are determined based off some settings. For example, if you have set that people need to register in order to read more, the link will say "Register to read more..."
The part that we're interested in here, however, since we want to turn images into links, is the URL that we want the images to link to. This is right in the first line:
<a href="<?php echo $this->item->readmore_link; ?>"
so we know that the URL is provided dynamically thanks to $item->item->readmore_link
and all this code is doing is echoing it into the HTML.
All that's left is to edit your Joomla template of the page on which you have your images (probably the same file you took this code from). It looks like this should be part of a greater PHP loop, which loops through all the posts. Somewhere above where you found this code, should be code for the intro image that goes along with that post.
I'm not sure what it'll look like, it could be a <img src="<? stuff here; ?> />
or it could be dynamically generated. Keep reading. If you're still not sure where to find it at the end, edit your post with the full code of the template where you got the above snipping from. Regardless of what it looks like, it is referred to as <WHATEVER IMAGE CODE YOU FOUND ABOVE>
in the following step:
You have to wrap that image with "a" tags so that it looks like the following:
<a href="<?php echo $this->item->readmore_link; ?>"> <WHATEVER IMAGE CODE YOU FOUND ABOVE> </a>
That should do it. Let me know if you have any trouble, I'll be more than happy to make my post more specific if you can provide more detailed information, but I've tried to explain it well enough that you should be able to figure it out with a couple tries.