These days there are quite a few types of computers which don’t have an optical drive built in. For the average user this is no great loss. Today Software is downloaded and not bought on a CD or DVD anymore. Also the CD has lost its popularity for exchanging data, people use the Internet or USB sticks. However, there is one big drawback for PCs without optical drives: For installing an OS you need to boot from the installation media. Without an optical drive you run into problems, because USB sticks aren't bootable by default and installing from a network is quite a hassle.
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So you either have to buy an external DVD drive or you make your USB stick bootable and copy the ISO image on it. As nobody wants to spend 60 bucks on buying an external DVD drive just for installing their shiny new OS most prefer the second option. Manually making the USB stick bootable is a pain though. Fortunately there are some applications available which exactly do that for you.
If you just want to install Windows 7 Microsoft offers the tool Windows 7 USB/DVD Download Tool (WUDT). In four steps it creates a bootable USB stick. All you need is an ISO image of Windows 7 and a USB stick bigger than 4 GB. At the moment you can’t download the tool directly from Microsoft, because it may violate the GPL. However, you can download it from various other sites, e.g. here. Despite its name you can also use it to install Windows Server 2008 and Vista.
If you sometimes want to try different OSes there is an application which usage is as easily as the WUDT but not limited to Windows 7. It’s called UNetbootin. For some Open Source OSes you don’t even need to download the according ISO file manually, it’s automatically done by the tool. You can see a partial list of supported OSes on the screenshot below, a full list is available here. Not only common Linux Distributions are supported, you can also find different Unix and Dos distributions.
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Can I do this with my external hard drive? I already have some data on it. Can I create bootable hard drive and still keep all my data?
You can’t use the WUDT for it. It only supports USB sticks. However, if there is free space left on your hard disk you can use partition tools like parted (for a review visit https://4sysops.com/archives/free-gparted-partition-manager-for-windows-and-linux/) to create a new bootable partition. I wouldn’t recommend using partition tools without having a backup of the data on the USB hard disk.