The idea is that if you are becoming upset about something unnecessarily, you might be twisting and turning and getting agitated. The speaker is imagining the agitated person's underwear getting tangled, so that it is no longer fitting properly, and is 'bunched up'. The British equivalent of this expression is ''Don't get your knickers in a twist" . Is that any clearer to imagine? Someone who is so agitated that their underwear gets twisted?

When something becomes bunched it means it gathers toward one area. For example, if I grab a shirt in one hand and have the whole width bunched in my hand (the top and bottom of the shirt simply hang). Or, closer to the phrase you mentioned, if your boxers (underwear that also covers the top part of your legs) are in a bunch, it's uncomfortable because the part that covers your leg is bunched upward. Used as a verb, at least here in America, we usually use the phrasal verb "bunch up", aside from set phrases like the one you mentioned.

The two answers you have received are great. However, the expression as I know it is Don't get your panites in a wad. (same as a bunch but that is the expression as we Gringos say it.