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I have been having some interesting troubles with this little guy. Rare is not as rare as some would have you believe. As a matter of fact I have found five rare Fel Flames since I have been hunting them and I have lost all five of them due to "Master" Traps not being so masterful. However I can confirm that these guys do spawn anywhere there is green lava seeping from the ground. I have found these little guys hiding all over Shadowmoon valley.
I got this one (Rare) last night. I can basically confirm that they do share a spawn with the large Flayers on the rise. Took me about an hour of farming before I finally got a rare to spawn.