May HAVA funds be used to purchase ballot paper that has security features such as watermarks or unique ballot identifiers? 

Yes. HAVA Sec. 101(b)(1)(F) allows funding to be used for improving, acquiring, or modifying methods for casting votes (e.g. paper ballots). Under this section, costs associated with purchasing or printing ballot paper with new or additional security features, including ongoing or future acquisition, are allowable and fully allocable to HAVA.