Only images in the Media Library can be converted. This is to avoid accidentally converting images in theme & plugin folders, or other locations where it may be more difficult to ensure that the database is updated with the new filename(s). Whichever image format is smaller is the one that will be kept. As of version 3.2, all images associated with a media library image, including resizes, retina sizes, and some custom theme sizes will be converted when the original is converted to ensure consistency and avoid filename conflicts. At this point, only references in the wp_posts and wp_postmeta tables are updated to point to the new image. If there is another location that the plugin should be updating, feel free to submit a feature request.
Hide Conversion Links
Converting images is not the most straightforward operation, in part because there can be references elsewhere in the database to images. To avoid having uninformed users converting images, use this to disable the one-click convert links that appear in the Media Library when using List view.
By default, the original image is preserved, in case you want to restore it for any reason. Once you're comfortable with conversion though, it can be a good idea to get rid of the original so you aren't wasting space.
Enable JPG to PNG Conversion
The JPEG image format is generally better for images with photographic content, so some screenshots, logos, and other images with limited colors may be better suited as PNGs. This option should be used with caution as it will slow processing down considerable. For example, the average photograph could take a minute or two to process with optipng, even more with pngout. This problem is less of an issue when using the API, as there are filters in place to make conversion more efficient.
Enable PNG to JPG Conversion
The PNG format is best for logos and other images with a limited amount of colors, while the JPG format is best for images that have lots of color, particularly photographs, but I see a lot of screenshots that fall into this category also. PNG to JPG is a lossy conversion because the JPG format discards data in the attempt to compress images. Additionally, the plugin will skip PNGs that have transparency, unless you set a background color to be used in the converted JPGs. If you want to change the default JPG quality used, you can do so on the advanced settings.
Enable GIF to PNG Conversion
The PNG format is generally just plain better than GIF, although it doesn't support animations (thank goodness), so there's really nothing to prevent you from converting your GIF files. Naturally, any animated GIFs will be preserved in all their splendor and NOT converted to PNG.