Of all the activities you can do with toddlers, phonological activities are the most important for developing literacy skills. Phonological awareness is the ability to distinguish and manipulate the smaller sounds within words. These can include syllables, onsets and rimes, and phonemes. But toddlers don't need to hear about all that. Direct instruction, especially with kiddos who know less than 200 words, is not the best way to teach phonological awareness. Activities are the way to reach toddlers.
Read, Read, Read
The key to developing literacy skills is reading aloud to your child regularly. This can be a challenge with toddlers, who seem to be on the go all the time. You can try reading to them when they are sleepy, thus making it more likely for them to sit still and listen. You can also try letting them walk around while you read and keeping it to one or two short, high-interest books. For the most phonological awareness improvement, choose books with lots of rhyme and language repetition, such as "Is Your Mama a Llama?" by Deborah Guarino and "Hop on Pop" by Dr. Seuss. See the first resource for more suggestions.
Sing, Sing, Sing
Try children's songs and nursery rhymes as a daily activity. Some of the songs and rhymes listed in Resource 2 include movements which will keep toddlers engaged as they listen to these verses that play with language. You can always create movements for other rhymes and songs. You can even create silly songs and rhymes about your child and her daily activities. The key is to play with language; your toddler doesn't care how corny the words are or how bad your singing voice is. Heck, your child won't even know if some of your "words" are just nonsense you used to fill in the rhymes.
Growl, Growl, Growl
A lot of toddlers will find it easier to imitate animal sounds than to imitate words. Your child may be even telling the cat "Meow" at this very moment. That's an ideal phonological awareness activity for improving sound recognition and developing sound meaning. You can introduce new sounds at the local zoo or petting farm, like, "The tiger says grrrrrrr!" or "The cow says mooooooo!" You can practice them by reading books like Eric Carle's "Head to Toe," which encourages animal sounds and movements.
Talk, Talk, Talk
It's adorable when your toddler comes up with words that sound like and have the same meaning as real words, such as saying "nana" for banana or "poonce" for spoon. But your kiddo understands far more than he can express, so don't just baby talk to him. Narrate his day using as many descriptive words as you can. Answer his questions and ask him questions that he can answer. When you go for a walk, describe what you see. The more words a child hears, the easier it will be to distinguish between and understand the meaning of them.