Should you have both of the boxes unchecked to be able to just keep the music file on the EHD only?
If you have it unchecked, it won't transfer anything, it will just read the files where they were originally are. This is good if you want all of your files in one specific place and not where you tell iTunes to store them.
However, if you dont' have the files in that place (or the place isn't there), the files wont' work.
What I do (and I think is one of the best options out there) is put ALL new music in one folder. I name it "Add to iTunes", and drop it on my main folder.
I put all of the files I want to add to iTunes in there and, with iTunes copying all files into the main central file, I add that folder into the library. Once everything is copied and automatically stored, I then delete everything in that "Add to iTunes" folder.
This allows me to know where and what is added and I won't ever have stray duplicates laying around my system. All of the files are organized for me (configurable in iTunes) so if I want to find and edit/copy/move something, I can instantly find it without having to resort to iTunes or any other program.