Is it possible to use water markes as the lock image. The desired effect is to have a thumbnail as normal for the album, but to have a watermark of a lock (for example) over it to signify it requires a password?

This will show the user the album thumbnail for identification, but also inform them it requires a password.

Check the plugins page. There is a plugin that will do this.

Thank you. I have had a look over them, but there is quite a few and cant find it. What was the name of the plugin?

http://www.zenphoto.org/2009/12/flag_thumbnail/
Although it is not really a "watermark", it just places an icon in a layer over the image.

I forgot to mention that there is an image option for showing the lock image thumbnail. So you will probably want to un-set that as well.