Discard local changes will literally discard the changes you've made to the file since your last commit or pull, so make sure you use it carefully! Although I'm not sure where you're seeing this option, the diff view offers the "Discard" button. The option is typically called either 'revert' or 'reset' depending on DVCS you're using.
You will see this in SourceTree 2.7.6 (Mercurial) for Mac when you have Uncommitted Changes in the tree, and then DoubleClick on the last Commit. If you check the "Discard Local Changes" in the ensuing dialog, you will be returned to the last Commit with no Uncommitted Changes, so all your changes since the last Commit are gone. Very convenient when you decide all the work you did since the last Commit should be trashed.
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