I've built a number of hot air engines with graphite pistons. I'll tell you what works for me. It might not be the best way, but it keeps me happy.
I use ordinary HSS cutting tools and run the lathe at 6-700 RPM. I always hold the nozzle of a shop vacuum cleaner to collect the chips and dust as they fly off the cutting edge.
For roughing, take a deep cut of at least 1/8" and use an agressive feed. That way, the graphite will come off as little pellets instead of a fine dust.
For finish cuts, use a very sharp cutting edge. I always touch up my tools with an India stone or a diamond hone. Use a fine feed and you'll get a good finish. You'll be making dust, so be sure to use the vacuum cleaner.
I don't know what it is about graphite, but either it or the binding agent is abrasive. It will be necessary to touch up the cutting edge from time to time. Again, an India stone works well. If you can see a reflection coming off the cutting edge when held in a bright light, the edge is not sharp enough.
After arriving at your final diameter, polish the piston with a clean sheet of typing paper, newspaper, or whatever else works for you.
Jerry Howell's Web site has some useful tips.
http://www.jerry-howell.com/
This page covers hot air pistons.
http://www.jerry-howell.com/Pistons.html
Like Jerry, I occasionally remove the piston and clean both it and the cylinder. I use a clean paper towel and a bit of de-natured alcohol to remove whatever residue that may have formed during operation.
Regards,
Orrin