Thymus daenensis, a perennial herb, is often grown in areas that experience drought conditions during its growing period. Application of chitosan may compensate for the negative impact of drought stress on the yield of oil and secondary metabolites in Thymus. The interactive effects of foliar application of chitosan and drought stress on dry matter, essential oil yield, and selected physiological characteristics including photosynthetic pigments, osmotic adjustment, and lipid peroxidation of Thymus were investigated in a two-year study from 2014 to 2015. Treatments consisted of 0, 200, and 400 μL L−1 chitosan applied to plants grown under field capacity, mild drought stress (50% field capacity), and severe drought stress (25% field capacity). Dry matter yield decreased substantially as drought stress intensified. However, essential oil content increased under stress conditions, with the highest essential oil yield obtained from plants under mild drought stress. Foliar application of chitosan compensated to some extent for dry matter and oil yield reduction of plants grown under drought stress. The highest essential oil yield (1.52 g plant−1) was obtained by application of 400 μL L−1chitosan under the mild stress condition in 2015 when plants were mature. The compensatory effect of chitosan in reducing the negative impact of stress conditions on dry matter and oil yield was due mainly to stimulation of osmotic adjustment through proline accumulation and reduction of lipid peroxidase level, which increased the integrity of cell membranes of thyme leaves