Mauricio,
For your image to maintain a circular shape, you will need to ensure that your image is a perfect square. Using type="circle" on a rectangular image will result in the “pill” shape you mentioned. So once you’ve cropped down your image to to have the same width and height, you will get the circular shape you’re after.
In regards to your second point, is your image surrounded by a link? Is that why you want it to have an effect on hover? Also, when you say a “faded image with text,” could you please elaborate a little more on what you’re trying to accomplish, or even provide a link to an example?
Thanks!