In the situation described, there are several drop options as well as the option to play the ball as it lies (from within the hazard), as pointed out. It's a good idea to read up on the rules and the definitions that the USGA (and R&A) use.
http://www.usga.org/Rule-Books/Rules-of-Golf/Rules-and-Decisions/
Yellow stakes typically define "water hazards" and red stakes typically define "lateral water hazards". There is a slight difference in the drop rules if your ball enters the hazards and I suggest players read up on those differences in Rule 26 (
http://www.usga.org/bookrule.aspx?id=14304 ).
You can play the ball in any type of hazard (note that out of bounds is not a hazard and you have no choice when out of bounds but to hit from where you last played a stroke), but as correctly pointed out above, you cannot ground your club, nor touch the water or ground with your hand, nor remove loose impediments. The restrictions are covered in Rule 13-4 (
http://www.usga.org/bookrule.aspx?id=14278#13-4 ).