The knife tool has the following options:
Selected - If checked only selected edges can be cut, otherwise all edges can be cut.
Add Edges - If checked connects the new vertices with new edges to divide the faces into smaller faces, otherwise creates only the vertices where the knife cuts the edges.
Select - Select which faces will be selected after cutting.
No selection - No faces will be selected
Inside - The faces inside the freehand curve will be selected
Outside - The faces outside the freehand curve will be selected
The selection is based on the center point of the face (whether it is inside or outside the curve).
Freehand - If checked a freehand curve can be drawn, otherwise a single line segment can be drawn.