By inserting the button from the Paypal widget in the Designs Gallery it will handle all of this for you, follow the steps in the Widget Guide, it takes you through step by step. When you click Insert it will automatically create a placeholder and insert into it the code that has been provided by Paypal.

Alternatively draw a rectangle, right click it, select Web Properties > Placeholder tab and in the Replace with HTML code field paste the code you've copied from Paypal (iasumming you've not inserted it by the widget).

The reason you're getting the 'unformatted text' option is because you've not pasted the code into a placeholder, you're pasting some text from your clipboard into the document so it's asking you what you want to do with this text.