Will raising the height of the thermostat in relation to the raidiator affect the function of the cooling system? Can it be above the height of the cap or does it need to be lower?

It should be lower than the radiator cap. How are you going to get all the air out of the system if the thermostat housing is the highest point? If you do put the thermostat higher than the rad cap then you will need a bleed hole on top of the thermostat housing. Chevy did this a bunch of years on their 2.2L cavaliers.

The position is unimportant. Makes no difference. Just make sure that it will flow enough to purge the air out.

Okay I just checked with a level and the thermostat itself wil be below the cap, but some of the waterneck and hose will be above the radiator. Is air above the thermostat bad as well?