dk,
Fractions cannot be reduced in the manner you describe when dealing with the operations of addition and sutraction.  Try substituting numbers for the x and y and you will quickly realize this. For example, 2/(2+3) equals 2/5 rather than 1/3, the answer that would result if the 2's were simply eliminated.
My approach to this particular problem was one of plugging in numbers.  Beginning with statement (1) and our AD/BCE grid, x>0 but we have no idea about the value of y.  Eliminate AD from the AD/BCE grid.
Statement (2) tells us that y<0, but we have no idea about the value of x.  Eliminate B from the AD/BCE grid.
Together we know that x>0 and y<0, but we don't know about the absolute value of either number.  For example, if x=2 and y=-1, the value of (x-y)/(x+y) = 3.  However, if x=2 and y=-3, the value of (x-y)(x+y) = 5/-1, or -5.  Since 3>1 but 
-5<1, the correct answer is E.
Can it be done this way: 
x/ x+y - y/x+y then: 
x's cancel and y's cancel so you get 
1/y - 1/x >1 or 
1/y-x >1