This option controls how threads and forums are marked as read.
Inactivity/Cookie Based - once a user has been inactive for a certain amount of time (the value of the session timeout option) all threads and forums are considered read. Individual threads are marked as read within a session via cookies.
This option is how all versions of vBulletin before 3.5 functioned.
Database (no automatic forum marking) - this option uses the database to store thread and forum read times. This allows accurate read markers to be kept indefinitely. However, in order for a forum to be marked read when all threads are read, the user must view the list of threads for that forum.
This option is more space and processor intensive than inactivity-based marking.
Database (automatic forum marking) - this option is the same as a previous option, but forums are automatically marked as read when the last new thread is read.
This is the most usable option for end users, but most processor intensive.