What is a virtual optical disk file and how do you create one?

By "Virtual optical disk file" it means an .iso image – a complete copy of a CD's or DVD's contents. (That is, not just the files, but also the complete structure.)

In other words, you created a blank VM, and now it's asking you to insert an installation disc so that you could install Windows (or Linux, or…) on it.

If you have an actual CD with Windows on it (or can buy one), you can use various tools to make an .iso image of it (like ImgBurn on Windows, Disk Utility on OS X, or the cp, pv, dd commands on Linux/BSD/OSX).

If you don't have a CD, download the .iso image from the net – all Linux & BSD distros come in .iso form, and for Windows there are both legal & illegal places to obtain those (e.g. MSDN).