I can't add anything to what Lime said - we're taking the same tack with DD1 (who is 3) and loooooves to play with it. She's been sticking things in it lately too, which has bugged me no end, as she just giggles when she gets caught and told off :/ I notice she usually does it when she's watching TV or just sitting around daydreaming, so I try to keep her hands occupied so they don't wander - off we go to wash our hands, here's some crayons, let's draw pictures for a while or go outside to play etc etc - and put your damn pants back on!
Hopefully she grows out of it soon, as does yours My DH *hates* that DD1 is always playing with herself, it drives him nuts, he can't stand the odour either (nor can I, I'm definitely going to try the tea-tree in the bath, Lime! Thanks for the tip!).