
I slap a lizard skin on the headset of pretty much everything I build up. Haven't had a headset crap out on me in many many years... Using FSA pigs may have something to do with this too...
On shocks where the lizard skin will be in contact with teflon coated sliding part of the shock they're a very bad idea as they'll rub the slider in grit as you cycle (Most air shocks fall into this category).
There are enough air gaps where the lizard skin fits around most headsets that holding water in the headset isn't an issue (Though it will probably affect the surface finish of the outside of the headset cup and the fork crown for the same reason it's not recommended for air shocks (I don't look under my lizard skin unless the headset is causing trouble, so I've no idea what things are like on my bikes at the moment).
Wrapping a lizard skin around the coil of a coil shock will help keep things clean and not kill the shock provided it doesn't dip enough between the coils to touch the shock rod.