Ahmed Jabari was the most senior Hamas official to be killed since an Israeli invasion of Gaza four years ago. Jabari has long topped Israel's most-wanted list. Israel blamed him for in a string of attacks, including the kidnapping of Israeli soldier Gilad Schalit in 2006.
Israel said the assassination marked the beginning of an offensive. It was followed by a string of airstrikes around Gaza.
On its Twitter feed, the Israeli military said it could be escalated further. "All options are on the table. If necessary, the (Israeli military) is ready to initiate a ground operation in Gaza," it said.
Israeli Prime Minister Benjamin Netanyahu was meeting with his senior Security Cabinet after sundown Wednesday, officials said.
Israeli officials said earlier that they were considering assassinating top Hamas officials following a wave of rocket fire from the Hamas-ruled Gaza Strip at southern Israel, triggering Israeli airstrikes that killed six Palestinians. The exchanges appeared to be waning on Tuesday.
The killing of Jabari seemed likely to re-ignite the flare-up. Palestinians called for punishing retaliation.
Witnesses said Jabari was traveling in a vehicle in Gaza City when the car exploded. Crowds of people and security personnel rushed to the scene of the strike, trying to put out the fire that had engulfed the car and left it a charred shell.
Hamas police cordoned off the area around a hospital where at least one body from the strike was taken. It was draped in a white sheet, with a burned leg poking out. Hamas said another man was killed in the airstrike. Hamas police said three other airstrikes hit other targets in Gaza City, Khan Younis and Rafah.
Plumes of black smoke wafted into Gaza City's skies following at least five airstrikes, in atmosphere reminiscent of Israel's large scale 2008-2009 attack on Gaza. Ambulance sirens blared as people ran in panic in the streets and militants fired angrily into the air.
Outside the hospital where Jabari's body was taken, Hamas official Khalil al-Haya eulogized Jabari and threatened Israel.
"The battle between us and the occupation is open and it will end only with the liberation of Palestine and Jerusalem," an emotional al-Haya said.
Outside the hospital, thousands of angry Gazans chanted "retaliation" and "we want you to hit Tel Aviv tonight."
The Israeli military said the assassination was just the beginning.
"After a couple of days on ongoing rocket attacks toward Israeli civilians the (Israeli military) chief of staff has authorized to open an operation against terror targets in the Gaza Strip," military spokeswoman Lt. Col. Avital Leibovitch said.
She said Jabari had "a lot of bloods of his hands" and that the military chief "authorized different targets" as well.
Shortly after, she said Israeli aircraft targeted 20 locations in Gaza that served as storage or launching sites for rockets. Among the weapons destroyed were rockets that could hit as far as 40 kilometers (25 miles) into Israel.
Advocates say targeted killings are an effective deterrent without the complications associated with a ground operation, chiefly civilian and Israeli troop casualties. Proponents argue they also prevent future attacks by removing their masterminds.
Critics say the killings invite retaliation by militants and encourage them to try to assassinate Israeli leaders. They complain that the strikes amount to extrajudicial killings.
Dovish Israeli lawmaker Dov Hanin condemned the killing.
"Assassinating leaders is never the solution. In place of the leaders killed, other will grow, and we will only get another cycle of fire and blood," he said.
During a wave of suicide bombings against Israel a decade ago, the country employed the tactic to eliminate the upper echelon of Hamas leadership.
During that period, Israeli aircraft assassinated the previous commander of Hamas' military wing, Salah Shehadeh, the movement's founder and spiritual leader, Sheik Ahmed Yassin, his successor, Abdel Aziz Rantisi, and dozens of other Hamas military commanders.
The practice set off a continuous wave of criticism from rights groups and foreign governments, particularly the strike that killed Shehadeh — a one-ton bomb that killed 14 other people, most of them children.
Israeli opposition leader Shaul Mofaz, a former chief of staff who has supported targeted killings, welcomed the strike.
"We need to continue this policy, to find them in every place," he told Israel's Army Radio. "Israel needs to determine the agenda, not Jabari."
Mofaz served as military chief of staff and defense minister when Israel carried out the earlier wave of assassinations. He and other former senior defense officials contend these killings left the Hamas leadership in disarray and put a halt to the rash of Hamas suicide bombings that killed hundreds of Israelis.
Mofaz warned that Israelis should expect an escalation of violence in the coming days following the assassination.
Jabari was known in Israel as the man who accompanied Schalit when the high-profile prisoner swap took place last October. Schalit, who was captured in a cross-border raid from Gaza that killed two other soldiers, was swapped for more than 1,000 Palestinian prisoners, including more than 300 convicted killers.
Jabari, nicknamed Abu Mohammed, was born in 1960 in the eastern Gaza neighborhood of Shejaiya. In 2006, he became the acting commander of the military wing of Hamas after his predecessor, Muhammad Deif, was seriously wounded in an Israeli attack.
Jabari began as a member of Palestinian President Mahmoud Abbas' Fatah party, but switched his allegiance to Hamas after serving 13 years in an Israeli prison.
He survived four previous attempts by Israel to kill him. In one attempt in 2004 his eldest son, his brother and three other relatives were killed.
He was credited with leading the bloody 2007 takeover of Gaza from Fatah forces, developing Hamas's military arsenal and its networks in Iran, Sudan and Lebanon and for his planning of the Schalit kidnapping. Hamas has ruled Gaza with an iron grip since then, and repeated attempts to reconcile with Fatah have failed.
The assassination threatened to further damage Israel's relations with Egypt, which is governed by Hamas' ideological counterpart, the Muslim Brotherhood.
On its official Facebook page, the Freedom and Justice Party, the Muslim Brotherhood's political arm, called the assassination a "crime that requires a quick Arab and international response to stem these massacres against the besieged Palestinian people in the Gaza Strip."
It accused Israel of trying to "drag the region toward instability."
Israel and Egypt signed a peace accord in 1979. Relations, never warm, have deteriorated since longtime Egyptian President Hosni Mubarak was ousted in a popular uprising last year.
Heller reported from Jerusalem. Additional reporting from Sarah El Deeb in Cairo.