It seems likely that a number of astronomical phenomena, such as the

It seems likely that a number of astronomical phenomena, such as the formation of planetary nebulas, may be caused by the interaction where two stars orbit each other at close range.

A. may be caused by the interaction where two stars orbit each other
Wrong.
- Likely + may ==> redundant.
- "where" modifies "the interaction" incorrectly ==> should be "the interaction in which....."

B. may be caused by the interaction between two stars that each orbit the other
Wrong.
- Likely + may ==> redundant.
- "that each orbit the other" is not grammatical ==> should be "that orbit each other".

C. are because of the interaction between two stars that orbit each other
Wrong.
- Note: Two idioms are correct: "between X and Y" --OR-- "between two X's" ==> do not assume "between two X's" is wrong.
- Redundant: "are caused by X" is better than "are because of X". GMAT prefers the order V-A-N (verb-adjective-noun). You should not use noun form if a verb form can do. Verb forms always convey better meaning than noun forms.
- Redundant: "interaction of" may be regarded better than "interaction between".

D. are caused by the interaction of two stars where each is orbiting the other
Wrong.
- "where" modifies "the interaction" incorrectly ==> should be "the interaction in which....."
- Progressive tense (is orbiting) is not necessary. Simple present tense is better.

E. are caused by the interaction of two stars orbiting each other
Correct.
Avoid redundant errors ==> correct & the most concise.

Hope it helps.