You can't upgrade unless you upgrade to Vista first. Best thing to do is make a backup of your XP and then do a fresh install of 7 and then reinstall apps/games.
Good, because using the "upgrade" option is always a terrible idea in the first place. But anyway, you potentially could, but you just have to be sure to select the correct drive to format and then install on.
After you've ran the Boot Camp Assistant and created a Windows partition, and once you've gotten to the Windows Installation Screen, you'll probably see a couple of partitions listed. Boot Camp Assistant will call the Windows partition "BOOT CAMP" in all caps. Just be sure to select that partition.
Please note that when migrating from Windows XP to Windows 7 you will not have an "in place upgrade" option. You will however have the option to select "custom" install when prompted. The Windows 7 install process will then copy all of your data in "My Documents" over to a Windows.old folder within Windows 7 itself. All applications and documents stored in other locations will have to be reinstalled / transferred manually.
For more information on the Windows 7 Upgrade, please go here: http://bit.ly/3DvynK
For additional assistance with the migration of Windows XP to Windows 7, please go here: http://tinyurl.com/mhbep4