Actually, I think it would be cool to have a grandfather who was a woman. But that’s just my weird sense of coolness.
I don’t think there are any rules here. What I would think about is what you want for yourself and your child. If your father is behaving unacceptably, I hope you can find a way to discuss that with her. Tell her that if she behaves in some way you consider to be appropriate, then she won’t piss off your husband or you, and might be allowed more access to her grandchild. If she can’t do that, then you can’t allow access to your child. These are the boundaries she must abide by for access. You child and your husband come first and if your father can’t respect that, then no access.
Or you could do it the way I did it. My parents behaved in a way we thought was inappropriate for our kids, so the kids stopped visiting them with no explanation. If they would have asked, we would have said, but they never asked. This is how things are dealt with in my family, and, well, it’s not likely to change. Too bad.
My great uncle had several children, and then changed gender and moved off to NYC to live as a woman. I never met him. Her. Whatever. He/she may have been bipolar, too. Which may or may not be related to the gender and sexuality issues.
It’s funny, now, thinking about meeting these people. The affinity we had despite never meeting each other before. Now, knowing the craziness we have in our family. There actually is a genetic basis for our oddities. There’s a reason why we are more the same to each other, even though we are so uncomfortable, elsewhere. Many of us travel much more than most. Many of us are artistic in one way or another. Oddly creative.
Certain people don’t fit well with conventional notions of normality. Honestly, I don’t think we’re all that different, but a small difference can be killing, sometimes. I think it would be worth coming to know your father, and having her know your child, if possible. I would face the weirdness issues head-on. If she can’t take it, then too bad. But if she can, then maybe you can negotiate a more acceptable way of being in each other’s lives. It can hardly get much worse, can it? But if you could make it better, on your terms, that seems like it could be a huge benefit.