There have been several earlier threads on this very topic, so I recommend you search (HOHR, octopus) to dredge these up out of the archives. Basically, if you read carefully, the well-shaft takes the PCs into the end of the 10 foot wide passageway at the top of the lower-level map. They then have to swim to the column in the middle of the room, climb the ladder, and operate the lever.
Octopi, being shell-less and boneless, can squeeze through very tight spaces. Based on contributions to the earlier thread, a 1-2 foot wide drain should suffice for a Large octopus. So the octopus presumably retreats into a drain tank when the water goes out, although octopi can survive out of water for a little while, and you could have it stay and fight the PCs if you want.
If the party merely sends a scout down the hole, he's probably going to be octopus food. But the octopus doesn't necessarily sit at the mouth of the 10' passageway waiting for PCs to walk down his throat either. Have the octopus lurk toward the back of the chamber and do opposed spot checks to see if it gets surprise. This way, PCs with good spot and quick movement might beat the Octopus to the ladder, if they're smart enough to swim to the surface and look around.
More likely, though, some PCs have to battle the octopus. In this event, hopefully the rogue or somebody has the smarts to evade the octopus and look for an alternative solution.
The smart party doesn't even put themselves underwater here without water breathing--they've already fought two underwater encounters in WC and should know that they are at a severe disadvantage if they can't breathe freely. It's a 3rd level cleric spell, and if they don't have it prepared, they can easily retreat from Sodden Hold and come back the next day. Freedom of movement, calm/charm/hold/dominate animal are also useful in this regard.
Basically, this room is potentially quite deadly, but not impossible by any means if the party uses their collective heads rather than relying on muscle power in a situation where they are at a severe tactical disadvantage.
My group had some small problems with this encounter, but no deaths. One thing to note is that the octopus can't grapple that well with just one tentacle and still threaten (takes a -20 to its grapple checks).
My group essentially swam through the room to the ladder while the barbarian began chopping off tentacles. There was a couple grapples and some mediocre damage done to the PC's, but they made it just fine. The octopus lost 4 or 5 tentacles and then took off on its own in a cloud of ink. Its still alive, but it isn't gonna mess with the group again until it regenerates its tentacles.
Don't forget that characters underwater take a -2 to attacks with slashing and blount weapons, and they do half damage. Characters also take a -2 to their grapple checks. Oh yeah, every round a character takes a standard or full round action underwater decreases the number of rounds that character can hold his or her breath without making a check by one round. Also don't forget that double armor penalty on swim checks and basically if your party doesn't do this just right get ready to cheat alot or see the PCs go down in the most ignomious fashion imaginable.