The Mysterious Stranger takes place when someone is conscious during a "Jaunt" as described in Stephen King's short story The Jaunt.It may be the boy in King's story, or it may be some other unfortunate, perhaps one really trapped in that in-between place for eternity. He brings with him notions of God, heaven, and hell, hallucinating something close to what he perceives as the reality he left behind. Satan represents an aspect of him that is somewhat sane and self-aware (at least by the end of the story), imploring the narrator to dream better dreams than the world he has imagined.
The mindscrew ending is Satan's way of showing that he really was fond of Theodor.We know that he believes that the only way humans can be happy is if they're mad, outright listing a god as one of the things a person can be happy believing themselves to be. Since Satan knows they won't be seeing each other again he gifts his friend with his version of "happiness", making him believe that he's the creator of the world; its God.