I'm pretty sure that you're partially correct with Theory B. However, it seems to me that you can fight the other Catholic factions to no end as long as you confine it to your territory.

If I control Caen and the French attack me in my province, they seem to get a warning, because the next time they attack, their standing with the Pope goes down. As long as I control Caen, I can attack French units on my lands without any warnings or penalties.

However, if the French take Caen, it is considered to be their province. When I lay siege to Caen to try to get it back, I get the warning, and then immediate excommunication if I follow through with the assault next turn. Probably something similar if I attack their free-roaming armies in that province, too.

This is why artillery is so important. Once another Catholic faction has attacked me, I move armies with heavy artillery to my borders. Usually they can reach and assault an enemy city in one turn's march. After I take the city/fortress, the province is considered to be mine and I can hunt down the AI's armies in that province with no penalty.

Of course, whoever starts a war by attacking first gets the warning - but it's always just a matter of time before all of your neighbors attack, and you will never have to wait too long.