Which of these is best, or are both okay?

"Isn't he cute?" said Casey, her arms wrapped around a bundle of fur called Pugsy. Katerina stroked the small dog.
"How long have you had him?" she asked.


or


"Isn't he cute?" said Casey, her arms wrapped around a bundle of fur called Pugsy.
Katerina stroked the small dog. "How long have you had him?" she asked.


To my mind it's not crystal clear as to where the new paragraph should start.

Grateful for any opinions.

Casey

Second one, otherwise it could suggest that Casey said the second line of dialogue.

You haven’t seriously called a dog Pudsey, have you?

Thanks Dee!

In the second example (it didn't show clearly when i posted) the second line is a new paragraph. Is that still not clear enough??

No! But i have called two Dachshunds Bossie & Digger, and a Shiatzu ' Marshmellow' - comments please, as i'm not naturally a doggie person

Casey

Second one, I'd say. Much clearer. And then you can cut 'she asked.', too.

Emma

Thanks.

Casey

Yep definitely the second. You should always have each new persons dialogue on a separate line, and anything relating to that dialogue, as in 'Katerina stroked the dog'.