My mum and dad were already Nan and Pop to my sisters kids so theirs stayed the same - can't have different grandkids calling them different stuff. Even though i am a let them shoos their own I have to say I really disliked my ILs wanting to be called the same thing as my parents (cos I really don't like them) so we insisted on Grandma and Grandpa so DD would know the difference. She has two Nans though that are DH's Nans too though.

Your step sister's little guy is related to your dad, families are made of always love not always blood. DH is my family and we aren't blood relatives. DF is your family and he isn't your blood relative. Yes I agree he's being silly. sweetie. Try not to get stressed over it now. It will often sought itself out without you realising. Perhaps you could bring up some cool grandparent names in a discussion one day and they (the ILs) take a fancy to them all by themselves.
I do however get why your DH is senitmental about those names. When I was a little girl I was quite sentimental about my Nana and Pop and I got quite agressive when DHs parents wanted to be that to my little girl - not that I'm saying DH doesn't like your family, but i get why he's hanging onto his train of thought too.