By default, only direct children. To display all sub-items, you have to toggle the preference extensions.zotero.recursiveCollections by going to about:config in the URL bar, filtering to that pref, and double-clicking it so that it's set to true (bold). Note that recursiveCollections isn't that thoroughly tested, but some people do use it, and we haven't heard of any issues.
When an item is located in a sub-collection, the function of highlighting the collection to which the item belongs (by pressing ctrl in windows) is only helpful when the parent-collection is expanded. When the parent-collection is not expanded it is impossible to see which of the sub-collections are actually highlighted.
It would be interesting to highlight the parent-folder (while not being expanded) to see whether an item belongs to that folder (or its sub-folders).
Setting recursiveCollections to true shows the items in the parent-folder but still does not highlight the parent-folder if the item belongs to one of its sub-folders.
Just a note that this feature is now available from the menu: You can toggle on and off as you want now by going: View → Show Items from Subcollections
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It would be interesting to highlight the parent-folder (while not being expanded) to see whether an item belongs to that folder (or its sub-folders).
Setting recursiveCollections to true shows the items in the parent-folder but still does not highlight the parent-folder if the item belongs to one of its sub-folders.
You can toggle on and off as you want now by going:
View → Show Items from Subcollections