In effect, this feature stops the brain-dead install of a piece of software that might infect your laptop. It doesn't guarantee that it won't stop the infection; but, at least, you will think about installing the software.
Option 1 is the "Mac App Store". That means NOTHING can be installed unless it comes directly from the Mac App Store. If you try to install anything downloaded from anywhere else, you will get a message telling you that you can not install the software.
Option 2 adds "Identified Developers" to the list of allowable installs. These developers are, presumably, vetted by Apple and therefore, you can trust that their software will not harm your laptop.
Option 3 is the WILD WILD WEST! Anything goes. You won't be prompted other than to enter your administrator credentials. Once you've done that the software will be installed.
I would heartily recommend either Option #1 or #2.
Remember, if you do NEED to install software from somewhere else, but you DO TRUST the software vendor, you can always select the "Anywhere" option and then come back to this applet and select either of the other two options.
The whole point is to get you to THINK before you act. Apple feels it's not enough to require administrator credentials before you install potentially dangerous software. Sometimes, just that extra time to think about it makes all the difference.