This effect uses a few free resources and Photoshop’s blending options – as with most of my tutorials, feel free to play around with the settings – you may find something you prefer – if not, you can easily go back or just delete the relevant layer!

Resources:

Occoluchi Outline Font from dafont.com
Starwalt Textured Florals Brushes from deviantart.com
Watercolour Background and Tainted Love Gradients – download here

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Step 1

Create a new file using the following settings:

Select the Type tool, Occoluchi Outline font, size 400pt, foreground colour black
Type your required letter
Right click on the layer in the layers palette and click Rasterize Type
Rename the layer ‘outline’

Step 2

Erase the ornament from the letter using the Erase tool, Pen tool or your chosen method.
Select the Magic Wand tool and click inside the letter
Select>Modify>Expand – set to 2px, click OK
Create a new layer
Fill the selection with white
Drag the layer to beneath the original text layer
Rename the layer ‘fill’

Step 3

Double click on the fill layer in the layers palette to bring up the blending options and apply the following Gradient Overlay and Bevel & Emboss settings:

Step 4

Double click on the outline layer in the layers palette to bring up the blending options and apply the following Gradient Overlay and Bevel & Emboss settings:

Step 5

Create a new layer
Select the Brush tool, Textured Florals brushes, foreground colour white
Select the first brush in the set, set the size to 450px
Click once on the canvas
Double click on the layer in the layers palette to bring up the blending options and apply the following Gradient Overlay settings:

Rename the layer ‘gem’
Duplicate the layer

Step 6

With the gem copy layer active
Select the Ellipse Marquee tool, hold down the shift key to maintain the proportions and drag out a circle the size of the gem

Hit the delete key – do not deselect
Make the gem layer active
Select>Inverse – hit the delete key
Ctrl + D to deselect

Step 7

Double click on the gem copy layer to bring up the blending options and apply the following Gradient Overlay settings:

Step 8

Drag the outline layer to the top of the palette – your layer order should now be as shown below:

Step 9

Ctrl + Click on the thumbnail of the fill layer to select the pixels.
Make the gem copy layer active
Edit>Copy (Ctrl + C)
Hit the delete key
Edit>Paste (Ctrl + V)
Double click on this new layer in the layers palette to bring up the blending options and apply the following Color Overlay settings:

Step 10

Turn off the visibility of the background layer
Right click on any visible layer and click Merge Visible

Step 11

Open the Watercolour Texture image
Edit>Copy (Ctrl + C)
Make your project active
Make the background layer active
Edit>Paste (Ctrl + V)
Add a layer mask by clicking on the icon at the bottom of the layers palette
Select a soft round brush
Make sure the foreground colour is black
Mask out the gem.
The finished project:

Here is another example, using 2 characters.
The ’1′ had the gradient overlay of the fill layer reversed.
Another floral ornament was applied, the same gradient added and it was rotated 180°, then a layer mask was added and parts of it were masked out.
The top part of the ’1′ was masked out to appear to be behind the ‘G’.
The serif of the ‘G’ was masked out to appear to be behind the ’1′.

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