This phrase comes from sports. When you "sit out" a game or a match, you sit outside of the court or field. So "sitting something out" means that you do not participate.

Like many phrasal verbs, "sit out" can have an object following it:

McMannis has had to sit out the last 3 games.

Or when you replace the object with "it", "this one", or another short phrase, it can come between "sit" and "out":

Why don't you sit this one out.