I've never had a smart cover and my Settings show the option under Auto-Lock and Passcode Lock. This is on iPad 2 on iOS 5.
If I remember correctly, Tim has an iPad 1. On my iPad 1 on iOS5, it's as Tim says; the smart cover option isn't showing in Settings.
OP, do you already have a smart cover and the option isn't showing? Maybe try resetting your iPad? If you don't already have a smart cover, maybe you could borrow one or try one at a store, see whether it will trigger on the option?