Knockout with Transparency Question

Hi,
I'm on a Mac, OSX 10.6.8, IDCS4. I'm trying to put a grayscale watermark of an image over a red background, with text above.
Three separate layers. Top=text, middle=grayscale PSD image with some totally transparent areas, bottom=solid red background.
The problem I am having is that if I lower the opacity of the grayscale image, it picks up the color of the red background. I want to keep it grayscale, but dimmed down. Is there an easy way to do this? I tried grouping the grayscale graphic and the red background, and clicking the "Knockout Group" box in the Effects panel. That didn't do it, besides it knocked out the entire square outline (much of which is transparent). I just want to knock out background behind the visible portion of the image.
I could use the pen tool and create an outline of the image, then put pure white copy of this over the red, then make a black duplicate and place it above the white copy....lowering the opacity as needed to act as a background for the image, but what a pain. There is probably an easier way to do this with native IDCS4 tools. I just don't know what it is.
Thanks,
Lou Dina

Thanks, Tman.
When placing a grayscale TIF, I can lower the tint after selecting the image with the Direct Selection Tool. It does fade, as you say. If I lower the Tint to zero, the image fades to pure white and I end up with a solid white rectangle. Much of this rectangle in my original is transparent. I tried saving the TIF as a single layer (not a background) with transparency, as two layers (bottom layer with a white background, turned off), as a transparent layer on top of a white "background" (also turned off), with and without alpha channels, etc. As you said, if I use an alpha channel or CMYK when placing the image into ID, the tint feature does not work at all.
Interestingly, if I place the TIF first, and THEN selecting Object > Clipping Path > Options, I can then select an alpha channel, it hides the transparent rectangle, but the slider works fine on the remaining image. If I invoke the alpha channel option when placing the image into ID, it doesn't work. So, that seems to be the key.
I appreciate the help. I learned something.
Lou

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