Up to 30 men, some with false beards and one masquerading as a pregnant woman in a wheelchair, entered the hospital in Hebron overnight.
They took away a suspect in a recent stabbing near Hebron after shooting dead his cousin in an altercation.
Ten Israelis and dozens of Palestinians have been killed in recent unrest.
Many of the Palestinian fatalities were attackers in near-daily stabbings of Israelis, shot by their victims or security forces.
The surge in violence began in September when tensions at a flashpoint holy site in Jerusalem revered by Jews and Muslims boiled over, amid rumours that Israel planned to relax long-standing rules to strengthen Jewish rights at the complex.
Israel has repeatedly denied such claims.
Closed-circuit television footage from al-Ahli hospital showed a large, armed group disguised as Arab men and women making their way down a corridor, pushing the wheelchair, shortly before 04:00 (02:00 GMT).
They point the guns at hospital staff, apparently ordering them to stay back.
Minutes later they are seen making their way back with the suspect, 20-year-old Azzam Shalaldeh, in the wheelchair.
Mr Shalaldeh is alleged to have stabbed and wounded an Israeli on 25 October before escaping after being shot by the victim.
Palestinian officials said Mr Shalaldeh's 27-year-old cousin, Abdallah Azzam Shalaldeh, was shot and killed in Azzam Shalaldeh's hospital room.
Israel's Shin Bet security agency said he was shot after attacking the Israeli forces. Azzam Shalaldeh's brother Bilal, who was also in the room at the time, said Abdallah Azzam Shalaldeh was shot without warning when he emerged from a bathroom.
Shin Bet said Azzam Shalaldeh belonged to "a family of Hamas militants", AFP news agency reported.
The Israeli military operates an undercover unit colloquially known as Duvdevan, which sometimes mingle undetected with Palestinians during riots before snatching suspects.
An undercover team also carried out a raid on a hospital in the West Bank city of Nablus last month, seizing a suspect in the murder of an Israeli couple days earlier.

The biker, 56, died in the crash on the A612 Daleside Road in Sneinton at 06:30 BST on Wednesday.
Nottinghamshire Police said the 50-year-old man, who was detained on suspicion of causing death by dangerous driving and failing to stop, has been bailed.
The Carlton-bound carriageway of the A612 was closed for several hours.
Earlier officers made an appeal for a second biker, who did not stop at the scene, to come forward.
Updates on this story and more from Nottinghamshire
Anyone with any information on the crash has been asked to contact the police.

Extern said it had been told the Intensive Family Support Service (IFSS) must close.
Charlie Mack of Extern said the staff had worked "tirelessly" to help vulnerable children.
The Department of Health said families would continue to be supported.
"Sadly we are the victims of not having a government in Northern Ireland at the moment," Mr Mack told BBC Radio Ulster's Evening Extra.
"All of the leaders of all the political parties (in Northern Ireland) have said it would be morally wrong if this service was stopped.
"As late as this afternoon we were pleading with the permanent secretaries to reconsider."
In a statement, the Department of Health said the pilot had "now come to an end and work has already started to consider how we successfully apply the learning identified".
"Families will continue to be supported by statutory services," the statement added.
"No cuts have been applied to any services.
"The Belfast Intensive Family Support Service was established in 2014 on a pilot basis for three years. Thus, since its initiation, it has always been scheduled to end on 31 March 2017."
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Undercover Israeli forces shot dead a Palestinian and seized a stabbing suspect in a raid on a West Bank hospital, Palestinian officials say.
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A man has been arrested in connection with the death of a motorcyclist who was killed on a road in Nottingham.
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Forty-seven staff employed by a Northern Ireland charity which works with disadvantaged families have lost their jobs after a three-year pilot scheme ended.