commanche,
As you can see in my personal info, I've "seen" better times and targets too! As you've been told, you want the rear peep sight to be as far to the rear as you can get it. It's meant to be out-of-focus so that the eye will center itself automatically in the opening. All you are trying to do is focus on the front sight/target.
What helps me the most after installing the peep sight was to place a piece of black electrical tape over my eyeglasses (ie. pin-hole camera). In my case since I'm left eye dominent, over the left-eye, (up in the inner corner) Now you'll need to put about a 1/16" hole in the center of the black tape and start experimenting with placing the tape in the exact spot in-line with the sights as you shoulder your muzzle loader. Get a sharp drill that will give you a good, round hole to view through. Start w/ smallish hole and work up larger until you find the best compromise for sharpness/brightness.
Jim