Most of my movies are ripped with HandBrake, then stored on my 250GB external. My external has a very annoying hum to it though, that gets somwhat annoying during movies, so I usually just copy the movie to my desktop, then eject the external. Then I delete the movie once I'm done watching it.
Next on the shopping list is a 200gb internal for my macbook, so I'll be able to keep some of my movies without the external. 😀
I watch all movies using Quicktime, not iTunes.