I think what is causing your problem is that your image is not inserted in your text as Mitou mentioned.
You need to place your text editing cursor in your text block at the point you want the image to appear initially, then do Insert--->Choose, or press Shift+Command+V.
When you do that, the image will be inserted into the text block, and you can then check the "Object causes wrap" box- then make final adjustments of where you want the the image, resize it etc. The key is the image must be inserted into the text block.