This is Act III scene ii, just before the staging of the dumb-show and the play-within-the-play, "The Mousetrap." Here, Hamlet is the opening act. He is performing a show in the audience. As the comic prelude to "The Mousetrap," Hamlet is playing a role he is good at, "Crazy Hamlet," ridiculing his mother, and angering Claudius in the process. This playful scene diverts attention away from the action of the real play (the Murder of Gonzago) and Hamlet's real motives ("to catch the conscience of the king") and furthers the theme of "appearance versus reality."
The only problem is that Hamlet's scene partner, Ophelia, doesn't know that she is to be part of the act. She plays straight, while Hamlet proceeds with the puns and sexual innuendoes, signs of what Freud called the "Oedipus Complex," repressed feelings of sexual jealousy aimed at an older male figure who shares a bed with the son's mother.
Remember, most of what Hamlet says to Ophelia in the play is directed at his mother. Here, she is present and open to public ridicule at the hands of her own son. Hamlet knows this will anger her and, more importantly, Claudius. His primary concern once the show starts will be watching to see if Claudius will show signs of guilt, and this pre-show comic act is but a way to rile up the king in a very public way.
We have much meta-drama here. The audience is watching Hamlet. Later, the audience will be watching the actors. All the while, Horatio will be watching Claudius. So, everyone is on stage here: "the play's the thing."
The risque banter is fraught with Oedipal connotations. A Freudian critic may say that Hamlet is sexually jealous of his step-father here, that he wants to be object of his mother's affections (in mourning) after the passing of his father; instead, she turns to Claudius for emotional and sexual consolation, much to Hamlet's dismay.