Somewhere in between is where you want it. The whole purpose/function of that skimmer is to create tons of microbubbles... think "ocean surf." You want all those bubbles that are carrying all the nasties to climb that tube that leads into your collection cup. If you set the cup too low, then the foam that makes it to the top of the tube will be too wet because it didn't have sufficient time for the "good foam" to drain back down the tube, into your tank. If you set the cup too high, then you make it too difficult (perhaps impossible) for ANY of the foam to get into the cup in the first place and it returns to your tank... in the form of bubbles.
I have this skimmer and it's not a set it and forget about it deal. I tweak it maybe once a week depending on the amount and color of skimmate produced. Right now, the black o-ring on mine is set maybe 1 inch below the top. Some mornings, I'll wake up to a full skimmer cup with pretty light color skimmate, for no obvious reason. I'll adjust the o-ring down a little and keep an eye on it. Then I'll usually end up creeping the o-ring back up. Over time, you'll get a feel for it.
This type of skimmer will produce a wetter skimmate than other skimmers, and that's OK. You just don't want it clear!