It's in the FAQ thread, but basically:
1) Be an Italian principality (not the Pope, not Genoa, not Venice).
2) Be Catholic or Counter-Reform.
3) Control 5 provinces in northern Italy (Lombardia, Firenze, Siena, Piemonte, etc.). Any 5 should work as long as they're on the "short" list in the event.
4) EITHER have high relations with the Pope OR Austria, OR have both Austria AND the Pope as vassals.
5) Have +3 Stab and <6 BB.
If this conditions are fulfilled, one of the three options will fire. The Pope and Emperor paths have their ups and downs; they give less BB and stuff, but the Pope path doesn't give you as many cores and both the Pope and Emperor can refuse your request for the crown of Italy. If you take the force majeur route, well, nobody can say anything. This is preferable, but watch out if you try to vassalize Austria later on.
The reason Venice, Genoa, etc. can't form the KOI is because they don't have kings. Venice is a republic, for example. You have to be an Italian prince to have a shot at being a king.