Oh, not sure about the photo. It makes Lily sound a bit vain and/or rather too serious about the relationship. A watch is also quite expensive (and he probably got one when he turned 17) so unless you want the gift to really be about her declaring that she loves him, then I wouldn't make it quite so extravagant. Could she get him something Muggle-ish that he'd be really amused or fascinated by? That way, it's individual enough to be only the sort of thing she could have got him, and James would appreciate the present because it can only be from her.
I'm still in favour of a charmed watch--maybe it could have a photo of the two of them on the face, which only James can see?