If you don`t wanna do it manually , try alien skin eye candy nature plugin for photoshop.
Else:P
In photoshop, you create the letter as text- color white(i used black background), duplicate layer, withe the letter on the back you rasterize type, and with the smudge tool you distort the letter however you want the smoke to be. When you`re done, you use a little blurr tool on edges. Then you apply a color overlay effect on the raster smudged letter to give it the color you want. The smoke layer that you smudged should look like image1 in my attachement. With the text layer visible on top of the one you smudged, it should look like image2. APply some effects on your top text layer(i used a color gradient and a red glow on image3, and the smoke a red color overlay).
I hope i wasn`t very ambigous and could help you 
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