Scott,
You have a cracked block. It doesn't really matter whether you drain the oil or not, because the only solution is to pull the engine and replace the block. BTW, you HAVE water in your oil. There are two things to keep in mind:
1) Oil floats on water, so water will collect at the bottom of the oil pain.
2) oil does not circulate through the dipstick tube, so if you are checking the dipstick and are seeing nice black oil that means absolutely nothing.
There are a few ways to verify whether there is water in the oil:
1) after running the engine, pull the oil filter or pull a valve cover. If the oil looks like coffee with cream, there is water in the oil
2) after running the engine, replace the oil filter. If the oil looks like coffee with cream, there is water in the oil
3) after running the engine. Drain the oil completely and look at the oil. If the oil looks like coffee with cream, there is water in the oil
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