Locate the studs in the wall where you wish to place the niche, using a wall stud finder. Run the stud finder over the walls and watch for the indicators to show the stud positions. Place a mark onto the studs.
Mark the location of your niche onto the wall using a straightedge and a pencil to keep the niche lines straight. You’ll want to place the nice between two of the studs, and position it so that the top and bottom edges of the niche are even with the grout lines of the surrounding tile wall. Place a straightedge over the niche area connecting the horizontal grout lines to either side and draw a penciled line at the top and bottom of your proposed niche location. Mark the vertical lines at a location that’s 1/2 inch inward from the stud edges toward the center of the cavity between studs, to give you room for the placement of the drywall sides of the niche.
Cut through the wall at the niche location along the drawn lines with a utility knife. Make multiple passes with the knife over the cutting lines until you've cut through the wallboard.
Use a tape measure to measure the distance between the wall studs, taking the measurement at both the top and the bottom of the niche space. Add 1/16 inch to the measurements, then cut a 2-by-4-inch plank to match the adjusted lengths with a circular saw. Place the planks into the niche, making sure you use the bottom plank for the bottom of the niche and the top plank for the top. Hit the planks gently with a hammer to move them between the studs until each plank fits horizontally in the space, with the bottom plank 1/2 inch below the opening of the niche space, and the top plank 1/2 inch above the opening. Secure the planks by driving two drywall screws through the wallboard and into the front of the planks with a drill containing a screw bit.
Measure the width of your bullnose tile to determine the depth of your niche, then add 1/2 inch for the rear piece of drywall. Cut two pieces of 1/2-inch drywall boards to the length and the modified depth of the niche, both top and bottom. Place the drywall pieces against the 2-by-4 planks installed on the top and bottom of your niche hole. Screw the top board directly to the top 2-by-4 using drywall screws. Place a piece of cardboard drywall shim, about 1/16 inch high, beneath the rear of the bottom drywall piece to tilt it slightly forward for drainage. Screw the slightly tilted bottom plank in place as well, driving the screws in at an angle so they’re flush with the drywall surface.
Measure the height of the niche on both sides, and cut drywall boards to match the height and the adjusted depth. Place them into the niche against the sides of the niche and screw them into place. The fronts of the four sides of drywall should be flush with the sides of the niche hole when installed.
Cut a piece of drywall board the height and length of the niche minus 1/2 inch to serve as a filler piece behind the rear of the niche. Place a 1/4-inch layer of thinset on the back of the board with a trowel, then slide it into the niche against the far wall between the studs. Apply a layer of thinset onto the rear of the original piece cut from the niche opening and push that into the opening against the drywall installed to serve as the rear of the niche.
Cut pieces of polyethylene waterproof sheeting to cover your niche. Make sure the sheets overlap by 2 inches along all seams and over the sides of the drywall, and that they fit flush against the niche rear and sides. Adhere the sheeting to the niche with thinset, then cover the seams with a thin layer of thinset as well.
Cut tile to fit the rear of the niche, using a ceramic tile cutter. Butter the tiles and set them against the rear surface. Use tile spacers between the tiles to keep the grout lines uniform. Use the bullnose tile to cover the edges and sides of the niche. The front of the bullnose tile should sit flush with the front of the niche.
Allow the thinset to dry overnight. Remove the spacers and use a grout float to fill the joint lines between the tiles with grout. Wipe off the excess with a damp sponge.
Finish tiling the rest of the surface surrounding the niche. The grout lines should fit horizontally, flowing under and over the niche in a straight line to provide continuity for your tiles.