The 22-year-old has played 19 times for the Spanish giants and was part of the Spain Under-21 team who won the European Championships in the summer.
Vallejo is on the fringes of the Real Madrid squad. He started four games last season mostly owing to suffering a number of muscle injuries.
He has previously spent time on loan with Real Zaragoza and Eintracht Frankfurt, where he made 19 and 22 league starts respectively. He had joined Madrid from Zaragoza back in 2015 for a fee of around £5million.
Wolves have been chasing a new centre-half all summer and still have an interest in Benfica centre-half and Portuguese international Ruben Dias, but a deal for the highly-rated 22-year-old is far from simple and negotiations are ongoing.
They are also still hopeful of signing AC Milan and Italy striker Patrick Cutrone. It's believed the team clubs have agreed a deal with principle and Wolves are now trying to convince the player to move to Molineux.
It's not thought that a season-long loan deal for Vallejo includes an option to buy the player.
Vallejo has played 22 times for Spain Under-21s.