You can upgrade
You can upgrade from XP, but it will delete all files on your machine. Back up to an external hd, or like I did, create a new machine with a minimal install of XP. Install Parallels tools, then shut down the machine. Configure the boot order under the Hardware tab so that CD/DVD is the first boot choice. Put the Win7 install disk in the dvd drive, and boot up the newly created machine. When prompted, click on the any key so that the installer will start. Follow the screen instructions until you get a choice of Recommended or Custom. Choose Custom! You'll then continue to follow the on-screen prompts and Windows7 will be installed.
When the installation is complete, re-install the Parallels tools. From then on, you should be good to go. Just remember, if you upgrade your EXISTING XP installation, you'll lose everything! I installed the 64bit version, so I don't mind reinstalling software, but to lose files would not be fun.
Hope this helps some,
Cathy