Hello I just downloaded latest Nexus dock from cnet. I am just loving it. However there is a gap between regular icons and running applications which is really annoying. I have pointed this with the red arrow in the screenshot. Would you please tell me how can I get rid of this (and also that separator if possible)
Anyways, It's the best dock I have ever tried.
Thanks.

You can't, sorry. That gap/separator is there to clearly mark where normal shortcuts end and running applications start.

Can the running applications be set to collapse into the shortcut icon and show thumbnails on hover? (Like the running apps do)

I've become quite accustomed to this in Object Dock

It's handy being able to show running apps without having a sperate running apps area, sort of neet and self contained.

Maybe I'm missing a setting?

You can't currently, sorry.

Adding a choice to do this is high in the to-do list, although there are some issues that need to be solved first, since, unlike with the Windows taskbar, in Winstep applications you can specify what left, middle and right clicking do for running tasks (WorkShelf Preferences -> Tasks -> Advanced -> Tasklist Actions).