That's right, jettru.....the images need to be in the main image directory, if you want just one image.....if you want more than one image, then the images STILL need to be in MAIN "images/medium" & "images/large" folders. And so do the watermark.png's.

mrmeech.......are you wanting just one image to be resized for each product, or are you trying for 1 small image on the index page, with a DIFFERENT, yet bigger image on hover (which will be the same as on the product info page), and yet a DIFFERENT, yet larger image upon click of the product info image?
If you want the same image, just resized, then you don't need ANY _MED, or _LRG images AT ALL.