Smart sensors in smart grids (SG) can provide real-time data and status of electrical power grids (EPG) for monitoring, protection, and control (MPC) applications to improve the reliability and resilience of EPG. However, there are major challenges for smart sensor data interoperability in SG, such as optional functions and implementations based on different interpretations of the standard. Interoperability modeling, testing and certification, and measurement and assessment methodologies help achieve and assure interoperability. This paper proposes a hardware-in-the-loop (HIL) simulation-based interoperability testing method for smart sensors in the closed-loop MPC use cases of EPG. In this testing method, a smart sensor, as hardware or device under test (DUT), is plugged into the closed-loop MPC application simulation of EPG to test its interoperability with the rest of the simulation system. A HIL simulation-based interoperability test case of IEC 61850-9-2 merging unit (MU)-based smart sensor is used to illustrate how the testing method works. This testing method not only tests how to exchange information between an MU-based smart sensor and the simulated protective relay (PR) but also tests how the PR can use the information from the smart sensor for MPC applications. Smart sensor users and manufacturers can use this testing method to develop testing systems to help achieve interoperability and, ultimately, plug-and-play of smart sensors.