How to embed images in html email

I would strongly recommend using a library like PHPMailer to send emails.
It’s easier and handles most of the issues automatically for you.

Regarding displaying embedded (inline) images, here’s what’s on their documentation:

Inline Attachments

There is an additional way to add an
attachment. If you want to make a HTML
e-mail with images incorporated into
the desk, it’s necessary to attach the
image and then link the tag to it. For
example, if you add an image as inline
attachment with the CID my-photo, you
would access it within the HTML e-mail
with <img src="https://stackoverflow.com/questions/1851728/cid:my-photo"
alt="my-photo" />.

In detail, here is the function to add
an inline attachment:

$mail->AddEmbeddedImage(filename, cid, name);
//By using this function with this example's value above, results in this code:
$mail->AddEmbeddedImage('my-photo.jpg', 'my-photo', 'my-photo.jpg ');

---

To give you a more complete example of how it would work:

<?php
require_once('../class.phpmailer.php');
$mail = new PHPMailer(true); // the true param means it will throw exceptions on     errors, which we need to catch

$mail->IsSMTP(); // telling the class to use SMTP

try {
  $mail->Host       = "mail.yourdomain.com"; // SMTP server
  $mail->Port       = 25;                    // set the SMTP port
  $mail->SetFrom('[email protected]', 'First Last');
  $mail->AddAddress('[email protected]', 'John Doe');
  $mail->Subject="PHPMailer Test";

  $mail->AddEmbeddedImage("rocks.png", "my-attach", "rocks.png");
  $mail->Body = 'Your <b>HTML</b> with an embedded Image: <img src="https://stackoverflow.com/questions/1851728/cid:my-attach"> Here is an image!';

  $mail->AddAttachment('something.zip'); // this is a regular attachment (Not inline)
  $mail->Send();
  echo "Message Sent OK<p></p>\n";
} catch (phpmailerException $e) {
  echo $e->errorMessage(); //Pretty error messages from PHPMailer
} catch (Exception $e) {
  echo $e->getMessage(); //Boring error messages from anything else!
}
?>

Edit:

Regarding your comment, you asked how to send HTML email with embedded images, so I gave you an example of how to do that.
The library I told you about can send emails using a lot of methods other than SMTP.
Take a look at the PHPMailer Example page for other examples.

One way or the other, if you don’t want to send the email in the ways supported by the library, you can (should) still use the library to build the message, then you send it the way you want.

For example:

You can replace the line that send the email:

$mail->Send();

With this:

$mime_message = $mail->CreateBody(); //Retrieve the message content
echo $mime_message; // Echo it to the screen or send it using whatever method you want

Hope that helps.
Let me know if you run into trouble using it.