Credit To: israelyates for letting us know how to do it - I just added in the pictures to help a bit.
(Settings > Preferences):
1. Check Advanced Options in the bottom right corner
2. Video > Output Modules > Image Video output
3. Video > Output Modules > Image File: here you can choose image format (I found that jpeg works better for me, because I think it's less of a chore for my comp); Recording ratio (i put 1 here because I usually want to extract EVERY frame and later sort it out, but if you don't need that you can have it make a snapshot every 10 frames or even more....); Filename prefix (I found it easier to make a distinctive prefix, like "vlcsnap-", but it's up to you)
You can also specify a directory where you want to save your stills. It's in general video options. This, however, doesn't work for me, because no matter what folder I choose it always saves snapshots in VLC's installation directory. If someone knows how to fix this, please, it's been driving me insane.
Now just load up your file and let it cap. It caps in real-time so it'll take the length of whatever you are capping to do it. Also when you open the file you'll only hear the file you won't actually see it, that's normal.
Remember that if you use VLC to watch video files you need to change your setting back to default.
TIP: If your computer can handle it I recommend doing your caps in PNG and then batch covnerting them to JPG.
TIP #2: onetimeoffer posted this and it's very useful!
I just figured this out today, so I thought I'd drop you a note in case you want to add it into the post. With files that have a wonky aspect ratio/dimensions, if setting the aspect ratio doesn't work (I'm capping an MKV file that refuses to cap at the proper dimensions), there is a way of setting specific image dimensions for the screencaps - under Video -> Image File -> Image width and Image height. You have to make sure they're properly calculated to keep the aspect ration, but it's possible to set it so that you won't have to resize later.