Netanyahu’s demand for a demilitarized Palestinian state spells trouble for Israel. The demand paints Israel as an unreasonable bully: surely, no state can be demilitarized. Germany and Japan accepted great limits on their armaments in return for American protection, but no one is going to sign a defense treaty with Palestine—both no one wishes to be dragged into a war with Israel and because Israel herself would prevent the Palestinians from signing such a treaty. Germany and Japan were forced to demilitarize because they were utterly defeated. Palestine is a somewhat equal negotiating partner who even has an edge over Israel in the UN.
Nothing precludes the Palestinians from agreeing to the demand and remilitarizing afterwards. Israel is not going to break a peace treaty over a few tanks.
Rewording demilitarization so as merely to bar foreign troops from Palestine won’t help. They can be as well stationed a few miles away in Syria. Iran understands clearly that Israel won’t tolerate it amassing a million-strong army in Palestine. A Foreign military presence, if any, would take the form of military instructors training local guerrillas, of which very few would be required to sustain a war of attrition with Israel. Such a low-key presence cannot be barred realistically, as can be seen in Lebanon.

Israeli should allow Palestine to be militant

A demilitarized Palestine would be outright dangerous because it would be a tempting target for takeover. Both Syria and Jordan have designs on the Palestinian territory, and Syria has designs on Jordan as well. Israel might find herself in the uncomfortable position of sending Jewish soldiers to defend Palestine, as she did for Jordan.
Israel, counterintuitively, needs a well-armed Palestine if such a state is to be formed at all. A militant state would serve as a buffer between Israel and Syria. It would also shift the center of gravity away from Syria, a development which might make Lebanon more stable and moderate. Strong Palestine and Syria would bleed each other with wars of attrition. Palestine lacks sources of income and technology, and would rely on Israel for weapons. Such reliance would assure Israeli-Palestinian cooperation more than any treaty. Other Arabs hate Palestinians, and a strong Palestine would be no less provocative for them than Israel, thus reducing the hatred directed at her.
But to try such a gambit as making Palestine a strong and militant state would require an Israeli leader of the caliber of Bismarck, rather than Bibi.