It is a superb episode, and one of my absolute favorites.
I love the atmosphere of it, the strange sense of phantasmagoria it's got going on. But that moment with the red shirt stands out like a sore thumb, and is made even worse by the ending (Picard has a pleasant little chat with Nagilum and gives it props for it's curiosity, apparently forgetting that one of his crew has basically been murdered!).
It isn't enough to ruin the episode for me though. Just a little niggle.