From Heinz Tschabitscher,
Your Guide to Email.
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Images in emails are great. If they are downloaded from a remote server whenever you open the message, they are a security and privacy risk, however. The sender (or spammer) can track when you open their message.

Fortunately, Hotmail can block these remote images, reducing the risk to zero. Instead of the image, you'll see a blank space, so you can still read the email (and you can still selectively view certain messages including all images).

Protect Your Privacy Against Web-Bugs and Remote Images in Hotmail

To protect your privacy in Hotmail by shielding against web-bugs and remote images:

• Select Options from the top Hotmail navigation bar.
• Go to the Mail category.
• Click on Mail Display Settings.
• Make sure Remove images until messages are reviewed is selected under Display Internet Images.
• Click OK.

Note that this setting does not apply to mail from people in your Hotmail address book. Images in these messages are always displayed.