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I was browsing through available options in wireless network properties and noticed under advanced settings option "Enable Federal Information Processing Standards (FIPS) compliance for this network".

What exactly does that option do? I've read the FIPS article, but it didn't enlighten me.

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It is referring to FIPS 140-2 Certification. I'd start by reading a simplified introduction and then something more detailed

FIPS 140-2 defines four levels of security:

Level 1. Security Level 1 provides basic security requirements via the use of at least one approved algorithm or approved security function. An example of a Level 1 cryptographic module is a personal computer (PC) encryption board.

Level 2. Security Level 2 improves upon Level 1 by requiring features that show evidence of tampering to attain physical access to the plaintext cryptographic keys and critical security parameters (CSPs) within the module.

Level 3. Level 3 attempts to prevent the intruder from gaining access to CSPs held within the cryptographic module. Physical security mechanisms required at Security Level 3 are intended to have a high probability of detecting and responding to attempts at physical access.

Level 4. At this security level, the physical security mechanisms provide a complete envelope of protection. Penetration of the cryptographic module enclosure from any direction results in the immediate deletion of all plaintext CSPs

So your product is probably not certified for FIPS 140-2 but claims some degree of compliance with level 1 of FIPS 140-2 by (presumably) implementing a stronger configuration of encryption parameters and handling of keys etc.

On a practical level, turning that option on will likely mean that some (older? cheaper?) devices are no longer able to interoperate with that device.

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