In Diablo II, Circlets, Staves, Wands, and Orbs have a special magic ability, or Magic Level, which allows players to receive higher level magical Prefixes and Suffixes on items from Monster Drops and when Gambling (Circlets Only). This bonus only applies to the bonuses that appear on the items themselves. This does not help generate better Magic Prefixes and Suffixes on other items if you are wearing them. So when you receive a Circlet via Gambling or a Monster drop the Magic Level helps increase the chances that a better Magic Prefix or Suffix will appear on it.
Circlets have an increased Magic Level which can add to the Monster Level which can allow you to receive higher Magic Prefixes and Suffixes.