Yuk Jaytree, even as a smoker (albeit a guilty one, going to give up soon) I think they (and your DH) are being completely unreasonable.
Although I smoke I don't think the habit is defensible nor do I think it's OK to inflict it on other people. I do smoke in public places where it's allowed (like the pub and I admit, ds may be there but I'd usually be outside or would smoke a few fags, reasoning that it's a big room which it usually is: still not good, I know, but as an exsmoker maybe you understand - you can justify anything, it's a horrible addiction) but I wouldn't dream of going to a non smokers house (especially one who had children) and expecting to be allowed to pollute everyone else.
You're not being unreasonable IMO, they are! But all that's not very helpful I don't suppose, what you want to know is how to handle it. Mmmm, well my dad was a heavy smoker too and I wouldn't let him smoke in my house when ds was small. No, it didn't go down well and it didn't make him very keen on staying with us but I enforced it.
But telling your own parent is one thing, telling your in laws is another. If you can't designate a smoking room then your options are, as far as I can see: a) let them carry on, go out as much as possible, seethe inwardly. b) lay down the law and say you won't accept it, thus possibly provoking big row with DH and in-laws. Don't know what else to suggest, maybe someone else has more creative suggestions? But you have my sympathy.