I have been trying to use the slideshow control so that the images fade in and fade out. I tried searching various forums out there but there is no actual solution for it. 
Finally I added up few AJAX animation effects to the slideshow container which would give you the desired effect.
NOTE: This is sort of an hack where in you have to manually time the fading in and out effects and the slideshow timing.
Also since this is continuous javascript this might put a little bit load on the user's browser.
Below is my code:
<script runat="Server" type="text/C#">
[System.Web.Services.WebMethod]
[System.Web.Script.Services.ScriptMethod]
public static AjaxControlToolkit.Slide[] GetSlides()
{
return new AjaxControlToolkit.Slide[] {
new AjaxControlToolkit.Slide("images/Autumn Leaves.jpg", "", ""),
new AjaxControlToolkit.Slide("images/Creek.jpg", "", ""),
new AjaxControlToolkit.Slide("images/Dock.jpg", "", ""),
new AjaxControlToolkit.Slide("images/Forest.jpg", "", "")};
}
</script>
<div>
<asp:Image ID="Image1" runat="server" Width="800px" Style="border: 1px solid black;
width: auto" ImageUrl="images/Creek.jpg" AlternateText="ME" /><br />
</div>
<cc1:SlideShowExtender ID="slideshowextend1" runat="server" TargetControlID="Image1"
SlideShowServiceMethod="GetSlides" AutoPlay="true" ImageTitleLabelID="imageTitle"
ImageDescriptionLabelID="imageDescription" PlayInterval="7000" Loop="true" />
<cc1:AnimationExtender ID="MyExtender" runat="server" TargetControlID="Image1">
<Animations>
<OnLoad>
<Sequence iterations="0">
<FadeIn Duration="10.0" Fps="5" />
<FadeOut Duration="10.0" Fps="5" />
</Sequence>
</OnLoad>
</Animations>
</cc1:AnimationExtender>