Wordorigins.org

This term for a lesbian is a clipped form of bulldyker, an American slang term that dates to at least 1906. The origin is unknown, but the fact that bulldyker is the earliest known form by several decades limits the possibilities significantly.

From J. Richardson Parke’s Human Sexuality (1906):

In American homosexual argot, female inverts, or lesbian lovers, are known euphemistically as “bulldykers,” whatever that may mean: at least that is their sobriquet in the “Red Light” district of Philadelphia.

The verb bulldyke, meaning to engage in lesbian sex, appears in 1921, a citation found in J. Katz’s Gay/Lesbian Almanac:

She had indulged in the practice of “bull diking.”

The noun bulldyke is first recorded in Peter Tamony’s Americanisms of 1931:

Bull-dykes Rendezvous...Men are not admitted.

And the fully clipped dyke is also first captured in Tamony’s 1931 work:

Benches in the more obscure parts are used continually by couples, pansies and dykes.

Douglas Wilson found an intriguing citation of Bulldyke being used as a nickname from the Decatur Daily Review (Illinois) from 29 July 1892. What connection, if any, this has with the modern slang word is not known. One assumes that Harvey Neal, alias “Bulldyke,” is a man, but there is always the possibility that the newspaper got that detail wrong or found the subject of homosexuality too distressing to mention:

With an idea of killing off a greater portion of the women of the levee district Hattie Washington, a colored woman, started out at 3:30 o’clock Wednesday afternoon with a big revolver in her hand. She went to Blanche Alexander’s place, at 101 Custom House place, in search of Belle Watkins, who, she said, had won the affections of Harvey Neal, alias “Bulldyke.” Bell [sic] heard of her coming and escaped, but as soon as the woman got inside of the house she began firing right and left.

The slang term for a lesbian is apparently unrelated to dike or dyke, meaning an earthen bank used to hold back or control the flow of water, a dam. This sense of dike is from the Old English dic, originally meaning a trench or ditch.

(Sources: ADS-L; Historical Dictionary of American Slang; Oxford English Dictionary, 2nd Edition)