I short all the time and I've never had such an issue, nor have I ever heard of such an issue actually occurring.
Gordon, yes there is the possibility a lack of volume would leave a short position out to dry. Avoiding shorting light volume stocks, and avoiding shorting ETFs altogether (because almost no traders short ETFs since there are usually inverse ETFs that do the job) will guard against this. Better yet, buy puts.
Use any broker besides IB & you don't have that problem. By Ib liquidations are done by a computer with 1 minute (not 10 minutes you mentioned), other broker it is done by a human being & usually takes hours or a day. Also when a "person" looks on your postion, they will realize if there is a mistaken quote..
+1 This... Never trade long OR short an instrument that cannot be liquidated in 30 sec or less. Also, if you set STOP LIMIT orders where the stop is the trigger and the limit is some OTHER price close to but within an "acceptable" range of sale prices from the stop price, then this will at least give you some breathing room if prices gap past a stop price. Also this ensures that your STOP is not triggered at market price as you have a limit in place. A STOP is simply a trigger that sells at market price. STOP LIMIT has an added extra margin of safety. However, as we all know nothing in this world is 100% and at any time you must be prepared for the worst and do what you can to prevent it.
there are about 3200 optionable stocks excl. etfs there are about 1750 optionable stocks that have adv above 500k so either stick to those stocks with high adv for lower b/a spreads and/or be prepared to spend more time working orders w/ less liquid options. re variables like cost/iv, you are right, although diff strategies can mitigate this somewhat if you're willing to give up some gains (put backspread/spread/etc instead of just buying a put). NEVER use market orders, period the end. even on the most liquid option like spy. just enter a limit buy at the offer or 1 cent above if you feel you must get in now - remember a limit order doesn't mean that's the price you pay - only the max price. i've checked trade executions and seen the price 1 or 2 cents below my limit when buying even a liquid option and been pleasantly surprised. bottom line i prefer being long options b/c i know the ABSOLUTE worst thing that can happen. i remember the VOW short squeeze - it didn't make sense but the losses were very real. if you bought puts you lose the premium. if you shorted your port was fubar.