If you delete a photo, it will be deleted from all locations. This is the same as doing an edit, the edit updates everywhere. The idea is all devices work as one. So, any action on a device will receive an equal action elsewhere.
As for the optimization, myself and others have the same problem. I have 6.5GB of photos on my device at the moment and that is the amount of space being used on my device. I have the option checked. If it were working correctly I would expect to see about 1GB of space used maybe. The 8.1 release Monday makes the beta available to everyone and it may also fix some of the basic issues people have seen. I would wait for the release and see what happens.