In several explanations of coinductive definitions (for example, in the answers to What is coinduction?), we're told that while an inductive definition gives us the smallest set with a specified set of properties (the constructors), coinduction gives us the largest set such with a specified set of properties (the destructors).
I'm having trouble understanding this because the notion of "largest set" doesn't seem like it should be well-defined. Clearly I'm thinking about this wrongly, but it would be helpful to know what my mistake is.
As a simple example that I've picked up from a few introductions, let's consider infinite streams over some alphabet $\Sigma$. We consider some set $\mathcal{E}$, such that if an element of $\mathcal{E}$ is of the form $\sigma{:}s$ for $\sigma\in\Sigma$, then $s\in \mathcal{E}$.
This makes some intuitive sense, even though it's a bit informal. (What does it mean for an element of an arbitrary set to "be of the form" $\sigma{:}s$?) But then the next part of the story is that we want the largest set $\mathcal{E}$ such that this is the case.
Here's my problem: surely the set $\Sigma^\infty$ of infinite streams does obey the specified property. But then surely so do other, larger sets such as $\Sigma^\infty\cup \mathbb{R}$. An element of this set is either an infinite stream (hence it's of the form $\sigma{:}s$ and we can conclude $s\in \Sigma^\infty\cup \mathbb{R}$), or it's a real number (in which case it's not of the form $\sigma{:}s$, but that's ok because we never introduced a rule saying it has to be). So it seems I can make the set as big as I want just by adding arbitrary members to it, and $\Sigma^\infty$ isn't actually the biggest set that satisfies the given property at all.
So where's my mistake? How can I think about the "largest set" in this context in a way where it's actually well-defined?
Note: I know that coinductive definitions can be formalised as final coalgebras of polynomial functors on $\mathbf{Set}$, and I actually understand that reasonably well. But I'm coauthoring a paper aimed at an audience who won't know anything about that, so my aim is to understand the more informal motivation for coinductive definitions, so that I can explain to the reader what's going on without requiring a lot of technical background. It would be quite helpful for me to know how this informal idea of "largest set" relates to the more formal notion of a terminal coalgebra.