The correct option is C dreaming
Option D is the correct answer."Fancied sight" does indeed mean dream in this context. The narrator's wife had died, and yet she remains in his dreams just as she was. That he was dreaming is further supported by the last line of the poem stating that he had woken up and then she was gone. The poem clearly states that the narrator can clearly understand when he's dreaming and when he's not, so neither is delusional, nor is he unable to separate reality from dreams. He pictured her as she was, with her virtues and beauty intact in her dreams. Therefore, it can be inferred that he didn't conjure up her image, nor view her beyond what she was. Thus, options A,B,C and E are incorrect.