What is the right course of action?

The yellow diamond sign means you are on a priority road. The sign below it shows that side roads join from the right, so you do not have to yield to traffic coming from the right here.

Because you are on the priority road, you have the right of way. You may drive through the intersection without yielding to the blue car, which must wait for you.

This explains why answer 1 ("I may drive through") is correct. The blue car has to allow you to pass because you are on the priority road. Remember, being on a priority road means you have the right of way until the priority ends or a different traffic sign indicates otherwise.