All you need for this tutorial is my virtual stitch. Just right click and save it to your computer.
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Open the knit_stitch.jpg

Open a new image 400 wide x 420 high

With your background set at pattern find the knit_stitch.jpg and fill your canvas with it.

Now we need to plan out our letter.
Anyone who has done this in the real world will have used graph paper but with PSP it is much easier.
Choose a simple font ( I chose Arial Narrow Bold ).

Add a layer and put your letter right in the center at only 20 pixels in size anti-alias off.
We now have to increase the size of the pixels to match the size of the stitches which are 20 px wide by 14 px high.

The math is fairly easy but here it is set up for you.
Note the settings are a bit different to normal.

Fade out the Letter layer a bit so that you can see through it.

Move the letter so that the pixels match the stitches and we are ready to outline the letter.
Set the "Freehand Selection Tool" to "Point to Point" - "Anti-alias" - "Feather = 2"
Now go around the edge of the letter following the edges of the stitches.
If your letter is not finished after going around the outside as in the case of an "O"
hold down "Ctrl" while finishing off the rest.

If you do this when zoomed in you don't have to be that accurate and should have a result like this.

We don't need the letter layer anymore so delete the layer.

To change the colour of the wool on the letter you will probably have to use
"Adjust" - "Brightness / Contrast" as well as "Colorize" ( Shift L )

When you colorize remember you are dealing with wool so keep the saturation level down.

We now need to make the knitting look a little more natural.

Use "Effects" - "Distortion Effects" - "Ripple"
and use these settings.

We are finished with the knitting for the moment
Add a new layer for the needle and increase the canvas size to 700 x 600.

Open your preset shapes and find the very simple arrow

With "Foreground" colour turned off and "Background" a pale colour draw a narrow arrow ( about the thickness of a stitch ) across the whole canvas.
The point will be too sharp so simply erase some of the point.

"Selections" - "Select All"
"Selections" - "Float"
"Effects" - "3D Effects" - "Inner bevel"
Use this setup

Add a new layer and with your preset shapes set to "Ellipse" draw an end for the needle adding the inner bevel in the same way.

In the "Layers" palette turn off visibility on the knitting layer, "Merge visible" and turn the visibility back on.

Now drag your needle into position above the knitting.

You now need to copy the original "knit_stitch.jpg" again.

Add a new layer above the needle and "Paste as Selection" moving it to a position on the needle.
With the "Raster Deform" tool pull it to about double it's height and a little narrower then round off the corners with the eraser.

Copy and then "Paste as Selection" one stitch for each column of stitches.
Don't worry about being too neat. - Wool isn't neat on a needle.
In fact make sure some loops are out of line.

All that is left is to add the tail ends of the wool.
Activate the "Knitting" layer and use the "Pen" tool
( size 8 - Freehand - Tracking 24 - color knit_stitch.jpg pattern )
Draw in a couple of ends.

"Merge Visible"
Tilt the graphic just for effect.
"Rotate" ( Ctrl R ) Left 10 o

If you are a perfectionist like me you will also want to shape the bottom edge of the knitting with the eraser or the Freehand selection tool.

Now resize to about 350 pixels wide remembering to change your settings back to "Smart Size", Lock aspect ratio checked and Resize all layers checked.
"Effects" - "3D Effects" - "Drop Shadow"
Vertical 13 - Horizontal 2 - Opacity 27 - Blur 2

Add a layer and move down for the background and put in a suitable background.
Your knitting is complete.