Drop cap is the first character of text (often paragraph) that is large and dropped below the current base line. It is traditional to set off the first letter of a story, section or paragraph with a capital letter larger than the remaining text. You can find drop caps used in novels and magazines.
The image blow shows an example of Drop Cap:
After you click the menu, it will open the dialog box as show in right image.
None: This option will not make any changes to your document.
Dropped: Your first letter of first word will occupy three lines and after that your other text will displayed. But all will be inside margin only.
In Margin: Your first letter of 1st word will be out of margin and remaining text will be inside margin.