Number 2.
Quotation marks go around the thing being said. In this case, Sara is saying— or rather, ‘crying,’ as in, saying in a needy or desperate voice/call— “I lost my hat!” You do not need quotations around Sara’s name, nor the explanation ‘cried,’ since that is what she’s doing— speaking (‘crying’). The words I lost my hat! are what’s being said so quotations go around either side, one in front of the first word/letter (‘I’) and one behind the last punctuation mark/letter (‘!’). That would make it,
Sara cried, “I lost my hat!”
