After some research, I found out that yes, that's exactly how it works. From Convention (IV) relative to the Protection of Civilian Persons in Time of War. Geneva, 12 August 1949:
"Nationals of a State which is not bound by the Convention are not protected by it. "Now, does this apply to the Palestinians? Remember that as of late November 2012, "Palestine" is a State and therefore it has all the responsibilities and expectations that come with it. As far as I know, "Palestine" has not signed the Geneva Conventions.
Does this mean that Israel can run roughshod over the Palestinians? No it doesn't, because the Palestinians make the case that even though there is a state of Palestine that ignores the Geneva Conventions completely, the people who live in it are under occupation and therefore still have protections as "protected persons" under the Geneva Conventions, even if they don't follow it. That's assuming that the Palestinians can continue to convince the world that they are in fact under occupation, even though Gaza technically is not.
Okay, so that covers Palestinian civilians. Now what about Palestinian terrorists? Well, when looking at how the US Army fights the Taliban and Al-Qaeda, American lawyers have deemed those forces as being "unlawful combatants." The definition of an unlawful combatant is a civilian who engages directly in armed conflict in violation of the laws of war. Would the Palestinian terrorists fall under the definition. They aren't part of a military, and they don't wear uniforms, which makes them civilians. Check. They are engaging in armed conflict. Check. And they violate the rules of war, most commonly by hiding behind civilians and directing attacks against civilians.
If you want to be technical, Palestinian terrorists, including captured ones, have absolutely no protection under the Geneva Conventions. Which is how it should be, as they don't follow the Geneva Conventions at all. When they are captured, Israel must have a "competent tribunal" decide whether he or she is an unlawful combatant. They can they decide to treat that combatant as a prisoner of war but they don't have to.
Of course, it is unlikely that any of this will actually affect the fighting between these two sides, because as the Arabs have made very clear at this point, the actual laws take a backseat to politics. Everything Israel does is "illegal" if you just say it loudly enough.