Welcome to SF!
The terms of the Upgrade version way that you must have a previous Windows OS on your machine to use it. No, it is not possible to use your XP key to activate 7. Whether you can install XP and use your other product key will depend on what XP license you have. If you have the retail version, I believe it would be legal. Or you could buy a cheap copy of XP online and install it, then upgrade to 7.
The whole thing is a little hairy, because Microsoft left it up to our honor to follow the license. It is fully possible to install the upgrade version without even having a previous OS!
If I were you, I would read the EULAs of your Windows and follow your conscience.