As tiny Porsche nearly puts a hammer lock on the sprawling empire of Volkswagen by tapping into loads of sophisticated derivatives instruments, one securities regulator gets particularly antsy about whether market manipulation is at work. Here’s how the luxury carmaker made like a hedge fund – even at the expense of the hedge funds themselves – in an acquisitive stealth play that’s as impressive as it is risky.

Porsche Automobil Holding SE is emerging as a potential big winner, and the target of heightened scrutiny, as hedge funds reel from billions of dollars in losses after betting wrongly that Volkswagen AG's share price would fall.

The small German sports-car manufacturer has moved closer to securing control of much-larger rival VW through a stealth strategy relying on sophisticated derivative instruments, and has been able to book big paper profits in the process.

Bafin, Germany's securities regulator, said Wednesday that it had begun a formal investigation into VW's share-price movements for signs of market manipulation. It declined to comment on whether it was investigating any individuals in particular. Porsche said in a statement it "denies all responsibility" for recent market distortions.

Continuing its gyrations, VW's share price plunged 45% to €517 ($656) Wednesday after Porsche said it planned to sell as much as 5% in options tied to VW shares. VW's shares had soared 348% over the two previous sessions -- briefly making it with world's most valuable publicly traded company -- fueled by Porsche's disclosure Sunday that it had boosted its VW stake to 42.6% and held so-called cash-settled options linked to another 31.5% of VW's shares.

Porsche said Wednesday it didn't break any disclosure rules by quietly building an ever-larger position in VW through the use of cash-settled options. Cash-settled options, which are settled in cash instead of shares, don't need to be disclosed to regulators under German law.

But a Porsche spokesman acknowledged that the company has made a "sizable profit" this year from the use of such derivatives, adding that it could help finance its VW takeover. VW is Europe's largest car manufacturer by sales, rolling out six million vehicles a year, compared with Porsche's annual output of 100,000. "We are a very small company buying into a very big company. That is not something you can afford if everybody is able to read your strategy in the newspaper," said Frank Gaube, a Porsche spokesman.

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