You are indeed looking at the transparency, there is nothing below that layer. Your Layer panel only shows your one layer.
The circles you created (with the eraser, I guess?) show the checkered scheme that denotes the transparency.
Without knowing what exact version of Photoshop, of your OS and platform (the screen shot shows Windows) I can't even begin to guess how you got the gray in there: some option in a tool somewhere, the paint bucket even…?
You can embed images in your posts by using the little camera icon in the Reply Editor of the forum's web interface.
It sounds like you may be new to Photoshop. It has a frustratingly steep learning curve. You may want to look in the Photoshop for Beginners forum here. In the FAQ there is a post about changing one part of your photo... But it is about how to make proper selections.
Also, as you point out, some of the older selection tools are really "crappy". Check this one video out about using the Quick Selection Tool and its Refine Edge command.