The best method to hold your pulleys is to machine soft jaws to about .005 smaller then the size you are holding, or same size.
If you have no soft jaws, I would use some brass shim's on your jaws and clamp very lightly, don't take heavy cuts.
As for putting keyway in, I used to put a HSS partoff blade in the tool post and slotted the keys this way.[Before I had my Slotter] You might have to grind it first to the correct size..about .0005 undersize, make sure, the blade sits nice and parallel, dial it up with a indicator, you can tilt the blade in such a way that you have clearance to the back.
Take about .003 at the time, use some tapping fluid and at the end of the stroke, move the tool away from the cut, before you travel back.
It looks like, a 1/8" keyway is about the right size.