The buttons come up set to On (defaults) but those settings are only applied if you click the Store in iCloud button.
My Mac is upgraded to Ventura 13.6 and the settings are slightly different.
However, for both macOS versions, I agree, optimization of Desktop and Documents from that setting isn't clear. I suspect that setting does also turn on optimization of iCloud Drive but I can't test it as I have so much free space on my Mac, even if Optimize Storage options are turned on it wouldn't optimize.
What I would do for iCloud Drive, is use Apple menu > System Settings > [username] > iCloud > iCloud Drive > Desktop & Documents folders to turn on Desktop and Documents (if you want Desktop and Documents to sync with iCloud) and then use the Apple menu > System Settings > [username] > iCloud > Optimize Mac Storage to turn on optimization for iCloud Drive (including Desktop and Documents) if you want it optimized. Or contact Apple Support for clarification.
The separate optimization option for iCloud Photos is in Settings (Preferences) inside the Photos app.