The freespace on your hard drive can be fragmented as well as your files.
Over time, as the system writes, modifies, and deletes files, the freespace will exist in various bits and pieces scattered across your hard drive. This leads to further fragmentation: when the system writes a new file, it may have to break it up if it is too large for the largest continuous freespace.
By defragmenting the freespace on your hard drive, you will improve Windows' performance when writing new files. You'll also help prevent new files from being fragmented.
To defragment the freespace on your hard drive:
If you select Defrag Freespace, Defraggler will fill up freespace chunks with whole files only. If you select Defrag Freespace (Allow fragmentation), Defraggler will use file fragments to fill up freespace.
You can also tell Defraggler not to move large files around while it's defragmenting free space. For more details, see this topic.
Which option should you use? If you want your freespace to be as defragmented as possible, choose Defrag Freespace (Allow fragmentation). If you want to reduce the amount of fragmentation in your current files, choose Defrag Freespace.