How to present in lecture a paper that students have read (or should I not have them read it)?
I recommend the discussion format. The two downsides of it you list can be overcome by using a guided discussion. When you assign the paper, also include a list of questions that you expect the students to be able to answer after having read the paper. When the class meets:


Select students at random (or through a random permutation).
Have the student answer an assigned question as a discussion seed.
Open up the floor to other students to make comments and pitch in their ideas (thus starting a discussion). 
When the topic dies down, move to the next question on the assigned list and repeat from step 1.


This format has several advantages:


It ensures that the students have read the paper (since they might get randomly selected)
It encourages them to think of their own answers and participate in discussions.
It eliminates the intimidating factor of the professor having tight control of the discussion (since you only moderate who speaks)
It lets you address the key points of the paper (through your initial selection of questions) without having to go over the whole paper in class.


I have experienced this format in upper level undergrad/grad courses during my undergrad and enjoyed it greatly. It really encouraged me to read papers and reflect on them carefully.