itermmojaveterminal
I tried to check Unlimited scrollback option in the iTerm2 settings, however, it doesn't seems to be applied for longer outputs (say couple of thousands lines). The output gets truncated so I can scroll up just to the last 1000 lines or so. 
I am running Mojave with ZSH 5.7.1 installed, the HISTSIZE is set to the 100 000 lines (however I don't think that matters to the terminal emulator). So is there something I am missing? Thanks for help
ls output with colors (ls -G) is not the default option. Run the following command in your terminal to enable ls colors by default:
echo "alias ls='ls -G'" >> ~/.bashrc
source ~/.bashrc
This and all future terminal sessions will now display colors correctly.
If you're still not seeing colors on your remote (or local) session follow these steps:
In iTerm verify that you're sending a terminal type that supports colors. Open the preferences window -> Profiles -> Default -> Terminal. I'd recommend putting xterm-256color as the Terminal Type.
While connected to the remote machine, run ls -G and open the iTerm preferences again: preferences window -> profiles -> Default -> Colors. Adjust the ANSI Colors, and turn the minimum contrast down until the colors in the terminal window start to show color.
If the remote system supports ls --color=always, remove any existing aliases in ~/.profile or ~/.bashrc and update as follows:
echo "alias ls='ls --color=always'" >> ~/.bashrc
Apparently, removing set lines=40 does the trick. The manual says:
Number of lines of the Vim window.
Normally you don't need to set this. It is done automatically by the
terminal initialization code
so be careful when you copy-paste ready configs, as I did :)
Best Answer
Unlimited scrollback might not work properly as expected, I am not sure why but it is may be because of the config of zsh.
So, I would suggest you specify the scrollback lines like 10000 (in my case) in the textbox and unchecked the "unlimited scrollback buffer" option