This post and the next have some further bits of advice, prompted by a couple of posts upthread. This one is about setting.
There is no single best way to use the setting in "story now" play. In some games, it is likely to be mere backdrop or context - after all, the imaginary events of play have to happen somewhere, and the setting provides those places. Some RPGs I've played where this is the case are Burning Wheel, Prince Valiant, Cthulhu Dark, Marvel Heroic RP, Wuthering Heights and In A Wicked Age. In this sort of RPGing, the opposition is likely to be introduced into play either (i) by decisions that the players make during PC build or during play - NPCs or situations that they are dealing with, for instance - or (ii) by the GM presenting the players (via their PCs) with a situation that speaks to somewhat "generic" player concerns for their PCs.
In saying that setting is backdrop or context, that doesn't make it uninteresting - upthread I posted an account of some BW play, which included a bazaar scene and a wizard's tower. When we were playing, I think these were quite colourful and engaging. What I'm trying to get at, in describing them as backdrop/context, is that they did not, in themselves, really generate the opposition or contain the players' concerns for their PCs. The BW episode I described illustrates (i): during PC build and during play, the player of the sorcerer PC had made demons, sorcerous cabals, and the like salient sources of opposition; and my facilitation and my narration of opposition introduced appropriate setting elements.
Prince Valiant and MHRP are two RPGs that (in my experience) exemplify (ii): the PCs have somewhat "generic" concerns, to do knightly things (Prince Valiant) or to do superheroic things (MHRP), and as a GM my job is to present situations that speak to these concerns, including appropriate setting elements. For instance, in a MHRP session where one player was playing War Machine, we began the session in Washington DC (because that was where our last session had finished) with the PCs going out to a bar in their civvies. Naturally, the women they met and were chatting up were supervillains (the "B.A.D. Girls"), hoping to target an exhibition of Stark tech at the Smithsonian and looking to get help (either inadvertent, or by way of manipulation or seduction) from Rhodes. The bar, the presence there of the villains, the exhibition at the Smithsonian: these were all made up by me as GM as part of the early back-and-forth of the session, framing the situation and setting the scene for (ie facilitating) the action. What makes it "story now" is that the way the scene is framed, and the subsequent action adjudicated, doesn't prejudge what is the "proper" thing for War Machine's player, and the other players, to have their PCs do.
Just to be clear, setting that is introduced as backdrop and context might still figure significantly in particular moments of action resolution: for instance, in the BW episode I described, at a certain point the players decided to have their PCs infiltrate the wizard's tower, and so appropriate actions were declared and resolved. In the MHRP game, Rhodes called in his armour via remote control, and then grabbed one of the villains and flew up to the top of the Washington Monument and left her dangling from it. To reiterate: describing the setting as backdrop/context is not dismissing it as a source of colour and an element of the action, but rather pointing out that it is not the source of opposition, player-established concerns for their PCs, etc - it is introduced subsequently, to facilitate and develop those things.
The contrast with this is provided by RPGs where setting is more than just backdrop, and is reasonably tightly integrated with the PCs and so more fundamental to players' concerns for their PCs and a source of opposition in itself. In this sort of "story now" RPGing, the players need to have a handle on the setting from the outset, so that they can position their PCs in relation to it. An example of this approach is 4e D&D played with the default setting/cosmology: 4e D&D presents the setting to the players in the race and class write-ups, and in the descriptions of gods and alignments); and it invites the players to build PCs with concerns directly connected to that setting - they are devotees of the Raven Queen, or trying to restore the glory of lost Nerath, or whatever else.
When GMing this sort of game, you will still need to introduce particular setting elements (eg places, people) off-the-cuff, but you need to make sure that when you do this you respect the established elements of the setting that the players have been building and playing their PCs around - otherwise, there is a serious risk of de-protagonisation, and pulling the rug out from under a player. At the same time, you still need to provide opposition as one aspect of facilitation, and to push the players to declare actions for their PCs. So judgement is necessary, and over the course of play hopefully you'll be able to build up a sense of how hard you can push.
To give an example: if a player chooses to build their PC as a Raven Queen devotee, hostile to Orcus, an interesting situation is one in which the player has to choose how hard they will push, and how much they will risk themselves and others, to pursue some undead. But it would be de-protagonising to present a situation, early in play, which reveals that the Raven Queen and Orcus are really collaborators, with their supposed rivalry just a ruse: because that undercuts the whole logic and orientation of the player's concerns for their PC. However, if over the course of play situations recur in which - as those situations play out - the relationship between Raven Queen, undead and Orcus seems to become more and more uncertain, then the idea that their hostility is manufactured or even pretence might be something that is put on the table. (When in doubt, follow the lead of the players.)
A given game might change its character over the course of play. An example is my Classic Traveller game, which began in a way fairly similar to what I described above for Prince Valiant or MHRP: the PCs had reasonably generic motivations coming out of the process of random PC gen that Traveller is famous for, and the earlier sessions of play focused on various situations that engaged those motivations, with setting being introduced by me as GM as it was needed. But as setting elements accreted, a sort of "deep history" started to emerge, involving psionic-using aliens, the opposition between psionics and the Imperium, etc. And some of the players have developed concerns for their PCs that are oriented towards this setting backstory and the associated elements that have figured in play. This puts an onus on me, as GM, to take care with those setting elements and not introduce new revelations or elements that would prejudge or undercut those player-established concerns, and hence de-protagonise those players.
I wonder if anyone who is familiar with the role of Duskvol in BitD could comment on whether it can manifest a comparable sort of trajectory, in the role the setting plays in the play of the game?