Flashing the factory image basically means a ground-up reinstall of all the software on the phone.. everything is wiped clean (by default, you can bypass the wipe if you want) and it's the most straightforward way to 'start clean'.
Now, the OTA image is often a smaller sub-set of files, stuff that changed since the previous version. Like all those security patches that get sent out that are only 50-100MB or so, which is considerably smaller than the full image. The OTA will go in and update what it needs to update, leaving the rest of the system alone.
As to which one is 'better', it all depends on you. Personally, I usually only deal with the full factory images when they are released (often long before people start to get the OTA update for that same release). I've been messing around with this stuff for a while and it's just easier for me. But the OTA updates, well, all you have to do is click on "Install" and let it do its own thing.