For a full understanding of palettes in SCI0 pics, see here.
You draw on the visual screen with one of 40 "colours", each one of which is composed of two of the 16 EGA colours. There are 4 palettes of 40 colours. A pic may be drawn by the game in any palette you choose.
The palettes are chosen using the palette button in the pic editor. This brings up a dialog
where you can assign colours to each of the 40 positions of each palette by right and left clicking
on the source colours at the bottom. When you close the dialog, the palette is set in
the command stream, at the particular spot in the pic. So you can change the palette many
times through the sequence of commands that makes up the pic.
If you check this box, then the entire 40 colours are written into the pic's command stream. This may seem inefficient, but it is may be the right thing to do, as the alternative has some often undesirable effects. If you only write the colours you changed to the command stream, then these colours become "locked". That is, no matter which palette the game uses to draw the pic, that colour index will always be drawn with palette 0's colour.
Generally, you insert palette commands at a particular spot in the pic (e.g. near the beginning). If you want to see what the final result looks like as you try out different colours, you can check the preview palette box. It will temporarily move the position of the pic to the end, while you manipulate the colours.