Windows on an external drive?

So I'm about to begin my set up of Boot Camp. I have an iso of Windows burned to a disc, have a legitimate key for that copy, and I have my Snow Leopard disc that came with my computer. I'm assuming then I would select "I have the Mac OS X installation disc that came with my Mac or I have already downloaded the Windows support software for this Mac to a CD, DVD, or external disk" and not chose the "Download the Windows support software for this Mac" when I'm in Boot Camp Assistent, but I'm not sure.

My main question though is, I happen to have a 500GB external HD. Could I actually use that drive to install my Windows on, or do I have to use part of my computer's HD for Windows? If I can use my external how do I do that? I've never done any of this so any help is appreciated.