Here is a complete solution:

1. Add attributes to each option, as @JMC suggests. However, I'd prepend the attribute name with "data-" to be in line with HTML5 standards. jQuery (as of v1.4.3) also supports retrieving attributes beginning with "data-" using .data().
2. Bind to the keypress event. This is more correct than keyup for the following reasons:
   1. Semantically, keypress means user input has happened, while keyup means the physical key is lifted. For example, holding down a key will generated multiple keypress events (for each character that appears on screen), while only one keyup event. Keypress is also not prone to incorrectly receiving the order of keypresses when the user types "QW" quickly, but lifts the "W" key (a keyup) before the "Q" key.
   2. Keyup will be generated on non-character keys such as the arrows, backspace, etc..., while keypress will not.
3. Use a timer to distinguish between two isolated key presses and a single sequence of key presses, e.g. did the user mean "W" for William Shakespeare and then "P" for Phillip Larkin, or just "WP" for ... Whatever Poet.

HTML

<select id="poetslist">
    <option value="shakespeare" data-initial="WS">William Shakespeare</option>
    <option value="milton" data-initial="JM">John Milton</option>
    <option value="keats" data-initial="JK">John Keats</option>
    <option value="wordsworth" data-initial="WW">William Wordsworth</option>
    <option value="larkin" data-initial="PL">Phillip Larkin</option>
</select>

Javascript

var timer = null, initials = "";

$("#poetslist").keypress(function (e) {
    initials += String.fromCharCode(e.which).toUpperCase();

    // Look for option with initials beginning with the typed chars
    $(this).find("option").filter(function () {
        return $(this).data("initial").toUpperCase().indexOf(initials) === 0;
    }).first().attr("selected", true);

    // Set/reset timer
    if (timer) {
        clearTimeout(timer);
        timer = null;
    }
    timer = setTimeout(function () {
        timer = null;
        initials = "";
    }, 2000); // Max 2 second pause allowed between key presses

    return false;
});