Peg has a small needle (5)
I believe the answer is:
tease
'needle' is the definition.
(thesaurus)
'peg has a small' is the wordplay.
'peg' becomes 'tee' (tee is a kind of peg).
'has' is an insertion indicator.
'small' becomes 's' (abbreviation - e.g. clothes size).
'a'+'s'='as'
'tee' placed around 'as' is 'TEASE'.
(Other definitions for tease that I've seen before include "Make playful fun of (someone)" , "Make fun of; comb wool" , "Use a comb" , "Rib, annoy" , "Playfully provoke" .)